Debt vs equity funding: what each really costs an Australian business

Here’s the paradox at the centre of this choice. Equity is the dearest money you can raise if your business succeeds, and the cheapest if it fails. Debt is the reverse: its cost is fixed on day one, and you owe it whether things go well or badly.

Everything else, from tax to control to paperwork, is detail around that core trade. Neither option is the sensible one by default. Each wins in a recognisable set of circumstances.

What’s the difference in one table?

	Debt	Equity
What you give	A promise to repay, plus interest and fees	A share of ownership
Lifespan	Ends with the final repayment	Open-ended, short of a share buy-back
Cash out each month	Repayments, regardless of results	None required; dividends only if declared
Total cost	Set by the contract	Depends on what the business is later worth
Control	Yours, subject to loan conditions	Shared; investors may want a board seat or veto rights
Tax	Interest generally deductible for business borrowing	Dividends paid aren’t deductible to the company
Security	Often property, equipment or a director guarantee	Usually none
Speed	Days to weeks	Typically months, including due diligence and legal work
Who suits it	Profitable, steady businesses	Early-stage, high-growth or pre-profit businesses

business.gov.au makes the same point in plainer form: debt lets you keep full ownership and ends once repaid, while equity avoids repayments but means sharing the business and its returns, potentially indefinitely.

How much does equity actually cost?

Owners often treat equity as free money because nothing leaves the account each month. It helps to price it.

Take an illustrative manufacturer raising $400k. Two routes:

• Equity: an investor pays $400k for 25 per cent of the company.
• Debt: a five-year loan where the total interest and fees come to, say, $140k.

Five years later the business sells for $4m. The investor’s 25 per cent is worth $1m, plus any dividends taken along the way. Under the loan, the owner would have handed back $540k all up, closed the account, and banked every dollar of the $4m.

Now run it the other way. The business struggles and is wound up with little value left. The investor shares the loss. The lender still expects repayment, and if a director guarantee was signed, that obligation can follow the owner personally.

So the honest question is: how confident are you that the plan works? The more confident you are, the more expensive equity becomes by comparison.

Why does tax tilt things towards debt?

The ATO generally lets a business claim the interest it pays on borrowings used to earn income, so every dollar of interest is partly offset by a smaller tax bill. Dividends paid to shareholders come out of after-tax profit. For a business already paying tax, that difference makes debt cheaper in after-tax terms, sometimes by a margin that matters.

There’s an important counterweight for genuine startups. The ATO’s early stage innovation company incentives give eligible investors a 20 per cent non-refundable carry-forward tax offset, capped at $200,000 a year for the investor and affiliates combined, plus a capital gains exemption on qualifying shares held for at least 12 months and under 10 years. That can make an innovative startup noticeably more attractive to investors than an ordinary business, and it shifts the bargaining power a little toward the founder.

When does debt win?

• The business is already profitable. If cash flow covers repayments comfortably, there’s little reason to give away future value.
• The money buys something with a clear return. Machinery, stock for orders already signed, a new shop fit-out, or opening another site once the first has proved itself.
• You need it quickly. A lender can decide in days; an equity round rarely finishes in under a few months.
• You want to stay in charge. Lenders set conditions, but they don’t vote at board meetings.
• The need is temporary. Bridging a cash flow gap with shares is like selling part of the house to pay one bill.

To check whether repayments are comfortably affordable, the debt service coverage ratio calculator is a good first step.

Wondering what a lender would make of your numbers? Start an enquiry here, and your credit file won’t be touched for asking.

When does equity win?

• There’s no profit yet to repay from. Pre-revenue businesses and those burning cash on product development usually can’t carry loan repayments.
• The upside is large and uncertain. If the business could be worth many times its current value, or nothing, sharing that risk with an investor is rational.
• You need the investor, not just the money. Industry contacts, distribution, technical skill or a seasoned chair can be worth more than the cash.
• Gearing is already high. If the debt-to-equity ratio is stretched, new equity can make the business bankable again.
• The sum outruns your security. Without property or hard assets, debt may simply not reach the number you need.

If you’re leaning toward investors, our practical comparison of a business loan versus investor funding covers what the process and relationship actually look like.

Are there options in between?

Several, and they’re worth knowing.

• Convertible notes. Money lent now that converts to shares later, often at a discount, usually at the next funding round.
• Mezzanine finance. Debt that ranks behind senior lenders and may carry an equity kicker. See mezzanine finance.
• Crowd-sourced equity funding. ASIC’s regime lets a smaller company (under $25 million in both gross assets and yearly turnover) sell shares to the general public via a licensed platform. The ceiling is $5 million in a rolling 12-month window, and each everyday investor can put in no more than $10,000 a year per company.
• Vendor finance. If you’re buying a business, the outgoing owner may agree to be paid some of the price in instalments. It’s still debt, just owed to someone who wants the business to keep doing well.

A checklist before you choose

1. Can the business make loan repayments from current cash flow, even in a slow month?
2. What would the stake you’re offering be worth if the plan works?
3. How soon do you need the money?
4. What do you want from a funder besides cash?
5. How much control are you prepared to share, and for how long?
6. What security can you offer, and are you comfortable offering it?

If debt looks like the right fit

Many owners who read this far have a trading business, a profitable year or two behind them, and a plan they believe in. For them, borrowing is usually the cheaper way to keep 100 per cent of what they’ve built. Telling us about it is a sixty-second job, and the enquiry itself is invisible to credit bureaus. We don’t auction your details to a queue of lenders. Instead, someone here works through what you’ve told us and gives you a ring to talk it over. Get the turnover, current debts and the sum you need right on the form, and the first suggestion we make is far more likely to stick.

See what you could borrow without giving up equity →