Should we raise capital via debt or equity?
Amid a financing drought, should business leaders bet on debt or dilute with equity? Himanshu Singh gives us his take
Nearly half of UK SMEs have paused trading in the last two years as they become victims of a financing drought at the very moment growth is most needed. With £20bn-25bn in corporate refinancing looming by 2027, and the Bank of England’s base rate stubbornly at four per cent, business leaders face a pressing capital conundrum: should they bet on debt or dilute with equity?
The funding crisis deepens
The stark reality facing UK businesses has intensified significantly. Series A funding has plummeted to a seven-year low of £2.4bn, representing a £500m drop from previous years. This dramatic decline means only one in 14 startups now successfully progress from seed to Series A funding, compared to one in four in 2021.
The broader SME landscape reveals equally concerning trends. Only 43 per cent of SMEs now use external finance, down from 50 per cent in Q3 2023, while 75 per cent of small businesses have never secured external funding. Perhaps most telling, over half of the UK SME owners have resorted to personal loans to fund their businesses due to difficulties accessing traditional capital.
The case for debt: Control comes at a cost
Despite elevated interest rates, debt financing retains appeal for established businesses seeking to maintain control. The tax advantages remain significant, with interest payments continuing to provide valuable tax shields that reduce effective borrowing costs.
However, current market conditions have fundamentally altered the debt landscape. UK SME lending reached £62.1bn in 2024, representing a modest 4.9 per cent increase, but challenger and specialist banks now dominate with a record 60 per cent market share, up from just 10 per cent when the Big Four banks controlled the sector.
The transformation is exemplified by specialist lenders like Simply Asset Finance, which has surpassed £1.75bn in cumulative loan approvals, growing its loan book by £505m in 2024 alone. This success reflects the agility of alternative lenders in serving SMEs abandoned by traditional banks.
Yet borrowing costs have soared dramatically. Southern Water’s bond yields have more than doubled to 13.5 per cent as the utility seeks to borrow nearly £4bn over five years. This extreme example illustrates how credit conditions have tightened across sectors.
The equity quandary: Growth, with strings attached
The equity landscape presents mixed signals. While UK venture capital investment reached £9bn in 2024, a 12.5 per cent increase, which masks deeper structural problems.
Early-stage funding shows resilience, with seed investment increasing by 80 per cent year-on-year and the number of seed-funded companies rising by 30 per cent. VC funds managed from the UK raised £4bn in 2024, almost double the £2.3bn raised in 2023.
However, growth-stage funding faces severe constraints. The number of companies completing Series A rounds fell to just 65-82 in Q1 2025, marking the worst quarter in 28 quarters. This “broken funding ladder” creates what industry experts describe as a “funding no man’s land” for consumer startups, too mature for angel investors, too small for venture capitalists.
Hybrid models and real-world plays
Forward-thinking businesses increasingly combine debt and equity strategically. Zopa Bank exemplified this approach, raising £75m in debt financing to avoid further equity dilution ahead of its planned IPO. This strategic choice allowed the company to maintain shareholder value while securing necessary growth capital.
Metro Bank’s recent performance illustrates successful capital optimisation, combining £250m in AT1 capital with strategic asset sales to deliver record £1bn in commercial lending. The bank’s approach demonstrates how carefully structured capital raising can drive profitable growth.
Market Reality and Future Outlook
The financing environment reflects broader economic uncertainties. Business investment by smaller firms remains historically low, contributing to the UK’s productivity lag versus other G7 countries. Only 10 per cent of businesses planned to increase investment over the past year, with demand uncertainty cited as the primary barrier.
The regulatory landscape offers some relief. Changes to the MREL regime will benefit smaller banks, while the Bank of England expects to reduce interest rates gradually if economic conditions remain stable.
For businesses seeking funding, the choice increasingly depends on stage, growth trajectory, and risk tolerance. Early-stage companies may find seed funding accessible, but those requiring growth capital face unprecedented challenges. Established businesses with steady cash flows may prefer debt despite higher costs, while high-growth ventures must navigate an increasingly selective equity market.
The £22bn SME funding gap identified across the UK economy underscores the urgency of getting capital structure decisions right. Success requires understanding both the evolving financing landscape and individual business circumstances, as traditional funding models continue their dramatic transformation.
Himanshu Singh is the founder and managing director of HSA Advisory,