Debt or equity: Every source of capital has a price

I’ve lost count of the files that land on my desk with the same story underneath. A founder took a 12-month loan to fund a three-year expansion.

A trader ran his stock on an overdraft meant for emergencies. A clinic owner started paying the bank before the first patient had even walked in.

When I dig into these businesses, most of them were never bad ideas. They simply borrowed the wrong kind of money. Now that angel investors and impact funds are becoming more active in Kenya, founders have more options than they did five years ago.

Just don’t mistake equity for free money. It comes with a partner, and that partner plans to stay.

Let’s start with debt, since that’s what most small and medium enterprise (SME) owners know. A loan will allow you to keep the whole business, and if your cash flows are steady and you have assets to pledge, it can be the cheapest money around.

However, the problem is that debt has no patience. Bank lending rates are sitting at about 14 per cent, and the instalment is due on the same date, whether your customers have paid you or not.

Use debt for stock that sells quickly, equipment that earns its keep, or invoices a customer has already confirmed. Don’t use it to fund an idea you’re still testing.

If the idea fails, the bank isn’t sharing that loss with you. That’s the gap angels and impact funds are meant to fill.

Networks like ViKtoria Ventures and the Africa Business Angel Network support early-stage companies, and the UK Kenya Tech Hub has been building up a new crop of local angels.

 Acumen, Alpha Mundi, DOB Equity and Catalyst Fund all invest here, mostly in agriculture, health, energy and financial inclusion.

In my experience, a good angel is usually someone who has run a business and already made the mistakes you’re about to make, and they’ll open doors you can’t open yourself.

Impact funds will wait longer for their returns, but they want proof you’re creating jobs, reaching farmers or treating patients.

The obvious attraction is that nobody comes knocking on the fifth of the month.

Your investor only makes money if you do. What founders often miss is the second benefit.

An investor will insist on audited accounts, a proper board and keeping your household spending out of the company books.

Those are exactly the things a bank looks for. I’ve seen businesses that raised equity well go on to borrow far more cheaply a few years later. My advice is to use equity to take the risk out of the business, then bring in debt once you know what works.

Equity has its own price, and founders tend to discover it too late. Every round you raise shrinks your share and if you sell too much too early, you could end up being a minority owner in the company you started.

Investors will want a say in budgets, senior hires and any future sale. Exits are not easy in Kenya, so expect pressure to sell or buy them out on their timetable, not yours.

Impact funds also come with heavy reporting and slow due diligence and with donor money tightening, deals are taking longer to close. With a loan, you pay interest. With equity, you give up some control.

The mistake I see most often is choosing out of habit. Some owners are so afraid of sharing their business that they borrow for something that needed a partner and then lose everything when the project runs longer than the loan.

Others hand over a big stake to fund ordinary stock that an invoice facility could have handled. My own rule is simple: Borrow for what you can predict and bring in a partner for what you can’t.

Patient capital is out there in Kenya, and it is being deployed. The real question is whether you’re prepared to match the money to the need, show your books to people you’ve just met and live with the plan you pitched.

The bank will want to see your collateral, and an investor will want to read your shareholder agreement. Could you handle both conversations tomorrow?