Beyond manufacturing a product, delivering a service, or managing operating expenses, every small and medium enterprise (SME) in the survival stage of business growth will eventually have to use its capital to innovate, improve efficiency and expand operations. All of these improvements will hopefully lead into the generation of above-average returns, and help the business break into the success stage of business growth.
Not all SMEs survive long enough to need financing sources for business growth – so if your business is growing so fast you need additional capital, congratulations! Beyond spending your own savings or relying on business grants, your options are small business loans in the Philippines, or investors and venture capitalists.
In business finance, these two options are more accurately called debt financing and equity financing. Both have advantages and disadvantages that depend on your company’s financial capability and desired level of growth, which we’ll discuss in detail below.
What is debt financing?
Debt financing is the act of obtaining capital by borrowing cash or getting a small business loan from a company or your network. For small business loans in the Philippines, you are obliged to pay the lender the amount you borrowed plus a monthly or annual interest rate over a specified period of time. Depending on the lender, you may also be required to pay loan processing fees, and late payment fees if you miss repayments.
How can you get debt financing?
For new entrepreneurs, small business loans in the Philippines may come from family, friends, or anyone else in their network – a form of debt financing known as informal loans. The personal nature of the relationship can lead to more accommodating loan terms, but you and the lender will not be covered by SEC’s lending regulations – which can be an issue if your rights as a borrower are violated.
Outside your personal network, a small business loan in the Philippines may come from the government and the private sector, such as banks and independent lenders.
There are several types of small business loans in the Philippines: term loans vs. credit lines, or a collateral vs. non-collateral loan. These debt financing options offer different advantages depending on your business needs and business finance:
- A term loan provides a large lump sum of cash upfront. It is best for long-term plans and big one-time purchases such as property or another business.
- A credit line offers a set amount, called a credit limit, that you can withdraw from any time within your loan term (typically 1 month to 1 year). It works like a credit card for businesses, where you only pay interest on the portion you used; when you make repayments, your credit limit is replenished and you can borrow again. It is best for short-term expenses and can be used as an emergency fund.
- A collateral loan is a term loan or credit line that requires a valuable asset, such as real estate or bank statements, to obtain. It is usually required by lenders for loan amounts of ₱2 million to ₱20 million or more.
- A non-collateral loan is a term loan or credit line that can be obtained even without collateral. Because they put more risk on the lender, they typically have higher interest rates than collateral loans, but they are a safer option for SMEs.
A more uncommon form of short-term debt financing is invoice financing, where you obtain extra capital by using your accounts receivable. It is also known as accounts receivable financing because it lets you borrow money against your outstanding invoices or accounts receivables. A third party, usually a financing company, will provide you a portion of your outstanding invoices upfront — usually between 60-80% — and charges interest on your borrowed amount until the invoices are paid in full.
What is “accounts receivable”? Accounts receivable are a company’s uncollected payment for products or services delivered. It is due within a year and is listed in the business finance’s balance sheet as a current asset.
What are the advantages and disadvantages of debt financing?
Debt financing is more accessible and can provide funds in a matter of days, especially if your loan amount won’t require collateral (around ₱5 million or less). With the rise of online lending companies, small business loans in the Philippines can be processed in as fast as 2-5 business days with minimal document requirements.
Debt financing is also more suited to SMEs that prefer to manage their business finances in-house. You also do not have to share business control or ownership with investors.
However, you may not qualify for a small business loan in the Philippines if you are a new business, if your business registrations are incomplete, or your business finances show inconsistent revenue. Most business loans in the Philippines require at least a year of profitable operations and financial statements. One exception is First Circle, which accepts applications from businesses of any age with at least ₱5 million in annual revenue.
If you choose a small business loan with collateral, you also risk losing your asset if you fail to repay. Some lenders also charge processing fees on top of interest payments, so if your small business loan has a high interest rate to begin with, you may end up paying more than expected.
If you need a small to medium amount to increase your inventory, fill cash flow gaps and fulfill short-term expenses, try First Circle’s Revolving Credit Line. It is a non-collateral form of debt financing that provides up to ₱5 million for as low as 1.39% interest rate per month.
What is equity financing?
Equity financing is acquiring cash from an individual or a group of investors in exchange for a portion of your business profits or business ownership. Unlike a small business loan in the Philippines, investors will not ask you to repay the amount they provided, nor ask you to pay interest or dividends. Instead, as co-owners, investors will have the right to provide input and make their own business decisions regarding your company’s direction.
What are the sources of equity financing?
Unlike small business loans in the Philippines, equity financing is open to businesses of any age and financial situation. New businesses can find informal investors like wealthy family members, friends, or acquaintances who believe in your business plan.
Businesses in the survival and growth stages, especially startups, can approach more formal equity financing sources such as angel investors and venture capitalists. Angel investors are usually rich individuals or groups who fund promising businesses in their early phases. Venture capitalists, on the other hand, operate more like firms. They offer millions or billions in investment financing to bring businesses to early or mature phases of growth, turning their investments into market leaders over a longer period.
What are the advantages and disadvantages of equity financing?
Equity financing is open to businesses in any stage of growth, as most investors only require a business plan and pitch that proves your company can be profitable. It will also be easier to obtain higher amounts by approaching multiple investors, and there is no risk of losing your assets or having to repay the capital you used.
Some investors are also experienced entrepreneurs who can mentor you on more complex business concepts, such as how to obtain an initial public offering or conquer a larger market. They can also connect you with better suppliers and potential customers.
The biggest disadvantage of equity financing is sharing control, business ownership, and profits with investors. Depending on your arrangement, you may have to share up to 50% with an active investor – which means you cannot make business decisions without informing them.
Investors, especially venture capitalists, are also highly selective. They prefer to invest in SMEs that disrupt traditional industries or have mass market appeal. These are usually technology-based businesses in the telecommunications, media, health, finance, transportation, logistics, or environment sector. For this reason, searching for equity financing can take months.
A unique form of equity financing for SMEs is First Circle’s Growth Partners Program, which offers zero-cost financing to high-growth SMEs that is equal to 10% of the business’s annual revenue. In return, First Circle becomes a shareholder with a 25% passive stake in the business. This program aims to grow promising SMEs to ten times their current capacity and value by providing them free capital and access to unique services like B2B payments, corporate cards, FX, and cross-border remittances.
Summary
Debt financing is best for SMEs that need smaller amounts, especially if they can present consistent business finances and have at least a year or two in operations. If your financing needs are short-term, or you do not want to share equity despite having a long-term financing need, this is the better option.
Equity financing suits businesses in any stage, but it is more likely to be an option for SMEs and startups that disrupt traditional industries or have mass market appeal. If you are willing to share equity and have bigger goals for your business, such as becoming a market leader in your industry, equity financing is your best bet.
