Equity or external financing

In order for businesses to grow, investment is required. These can be financed either by reinvesting the company's own resources, or by raising external capital. But how should you think as an entrepreneur when faced with the choice of whether to finance an investment with equity or external financing?

‍

‍

Equity

Equity is the difference between a company's assets and liabilities. When a company generates profit, it increases its equity. In order for the company to continue to grow and hopefully generate higher profits in the future, it is often a natural choice to reinvest all or part of the profits in the business. This can be done by the company making investments, paying off debts or increasing cash flow to improve liquidity. Using the equity and current income, it is The most common way to finance investments among Swedish entrepreneurs.

‍

‍

External Financing

Access to capital is a prerequisite for enabling companies to grow. However, for many small and growing companies, equity is not enough to invest, and external capital needs to be used to finance the investments. There are several different forms of external financing, but most of them are business loans The most common way to finance investments.

‍

‍

Investing with equity or external financing?

Whether it is best to invest with equity or with the help of external financing may differ from company to company and from investment to investment. It is therefore important to have an understanding of how they differ, how they affect key indicators in the company and when the investment is expected to yield results. This is so that you can choose the financing that will allow your company to get the maximum return on investment.

‍

‍

Solidity

When investing, the solvency of the company will increase or decrease differently depending on whether you reinvest the equity or if you use external financing. Solvency is a measure that indicates the proportion of assets financed using equity and is used to describe the long-term solvency of a company. When equity is reinvested in the company, the solvency will increase and, correspondingly, it will decrease if the investments are made with external financing.

‍

Therefore, when you are going to invest, it is good to make sure what solidity you have in the company. If your company has low solvency, investment using equity is preferable. On the one hand, solvency will increase, and secondly, because the company's own money may generate a better return than if it were simply lying in the company's account. However, investing with equity is relatively expensive compared to, for example, a business loan as most entrepreneurs want to generate a higher percentage return than the interest rate that the loan has. Therefore, if the company has a high level of solvency, it is preferable to finance the investment with external financing.

‍

‍

Type of investment

The type of investment you intend to make can also have an impact on which financing may be preferred. Reinvesting profits in the company is, as I said, an important part of healthy entrepreneurship, but a relatively expensive way to finance investments. Investing with the company's own capital also means withdrawing the cash, which affects the short-term solvency of the company. If the investment is made in an asset that can be quickly turned over and generate income for the company, equity can therefore be a good way to finance the investment. If the investment is instead made in an asset that will be used for a longer period, it is usually better to finance it with external capital. This way you do not risk the liquidity of the company and thus the short-term solvency. However, it is not only the ability to pay the company's debts that affects whether to look at liquidity and which financing you should choose. Virtually all companies are run for profit and with the goal of generating returns for the owner. Therefore, if your company has good solvency and liquidity, financing with, for example, a business loan can allow you to both drive growth in the company, while at the same time, as an owner, you can use part of the cash to distribute part of the profits to yourself and get a return on your work.

‍

‍

Invest in time

Another aspect to consider is when the investment needs to be made. Most Swedish companies are restrictive when it comes to indebtedness and choose to use their own capital and save for investments, which is not optimal. If companies save for investments, the investment risks being made too late and thus not having the desired effect. When you wait with the investment, you also miss out on the expected return while the investment is pending. This not only means that you as an owner miss out on increased profits and potential dividends, but also that the growth of the company deteriorates when the returns could have been reinvested in the meantime.