Navigating new capital: debt financing for small and growing companies

If you own a small and growing company, there will usually be a need for new capital to expand and continue to grow. Once you have exhausted early-stage equity investments, starting with family, fools, and friends, your company will likely turn to convertible loan notes.

These convert to equity on certain events, like an acquisition, a large new investment or an Initial Public Offering. There are however many other debt instruments available to small and growing companies.

The forms of debt instruments in the loan market are as diverse as the range of tech gadgets in a Silicon Valley store. They come in many shapes and sizes from overdrafts to syndicated loan facilities with a number of lenders. As with equity, it is a question of cost and control. How much of both do you need to give up for the benefit of obtaining capital?


Most businesses will be able to obtain an overdraft. This is usually an uncommitted debt facility, backed by, for example, cash that is already in the company’s bank account or assets belonging to the company. For a standard arrangement fee and accrued interest, an overdraft provides some flexibility. This is perfect for growth companies that may have raised a lot of equity capital but want short-term cash flow flexibility.

Overdraft facilities are usually on bank standard terms (in other words, they are “very bank friendly”) and are repayable on demand. However, banks can recall overdrafts for any reason. If there is any sign of the company underperforming, or the bank has changed its internal risk exposure policies and no longer wants exposure to crypto assets, for example, or simply because it is having a bad year itself, the overdraft can be recalled.

Committed loans

Companies may prefer debt facilities that are “committed.” This means that the company pays a commitment fee for the ability to draw down debt without banks having control over when the debt is repayable. The bank must set money aside to be available when the company requires it. Making such capital available to a company comes at a cost, and banks will want to protect themselves in case there is a material change to the circumstances of the company. This inevitably makes the documentation longer, but it also opens up the ability to negotiate.

Legal documentation gets longer when the size of debt grows – as banks need greater protection for their increased exposure. To raise £2,000,000, you may get away with a 10-page document. To raise £60,000,000, you are unlikely to manage with much less than 40 pages. For amounts in between, the length of documentation will depend on how risky the bank considers the debt to be.

More risk means more controls being imposed on a company. As risk and debt size grow, there are more deliverables associated with entry into finance documentation. These include board minutes, financial accounts and bespoke security documents. Banks will also want to ensure that they have priority over any other debt in existence, whether intra-group (where subsidiaries and parent companies form part of the structure) or loan notes provided by initial investors.

Increasing controls and requirements

As debt size increases, documentation and controls become more standardised, and most banks will propose their preferred form of documentation to a company to cover a transaction.  Lawyers are familiar with these forms and can explain away the jargon.

Banks will usually introduce financial covenants at this point too. This is an obligation to comply with certain financial metrics (e.g. overall debt, cash cover, a debt to earnings ratio) on a quarterly or annual basis. As banks perceive greater risk, they will add more controls. They will also restrict the use of their debt so there can be no leakage from the company through dividends, or acquisitions that are outside the ordinary course of business or would otherwise dilute a bank’s position.

Banks will also regularly ask for security, whether in the form of a mortgage, security over intellectual property or a guarantee, in order to de-risk their position. Giving security allows bank to provide financing or provide it at cheaper interest rates. Companies need to consider what security they can give in the context of what they may already have given and their imminent plans for raising further debt.

Negotiate, negotiate, negotiate

Companies should always negotiate the terms of any finance documentation so that the documents work for them.

This means checking there are no triggers that your company would not be able to comply with from day one. It also means ensuring that the company has the manpower to provide any required documentation to the bank on a regular basis and that the terms are aligned with the needs of the company. For instance, if you have no real estate and your business model does not propose for your company to hold real estate, you should not need to include terms in your finance documents that are only needed for real estate.

Who will provide the best deal?

Commercial banks provide standard loan products on a short form, repeat business basis to companies holding bank accounts with them. However, there are also non-bank lenders who provide committed facilities. Companies seeking loan financing may sort through potential counterparties by reference to the amount of capital deployed per company.

Some lending institutions will specialise in smaller loans, whilst others will specialise in high-risk loans (with higher interest rates). On the high-risk end, companies may find that the lender will also ask for an equity interest through the grant of warrants as a condition to providing the debt instrument.

For small companies, it is worth exploring possible debt providers and obtaining several debt term sheets to compare amounts and interest rates that might be available.  Where banks deem a company riskier, they will usually shorten the length of the loan, increase the interest rate and apply a hefty default interest rate after payments become due. These items need to be weighed up against the company’s growth plan and their ability to raise more capital.

It’s all about relationships

For small and growing companies, debt capital is often a lifeline permitting speedier growth, which might make companies less inclined to negotiate their initial terms. There is usually scope to mould the debt product into something that will work for all parties. Banks may be constrained by their internal credit processes, but they also benefit from creating a long-term relationship with a growing and successful company.