Debt Vs Equity Financing For Business Entrepreneurs
As an entrepreneur, at some point you are going to need funds to take your business to the next level. The question is, should you get a business loan or an investor?
Let’s face it. Obtaining capital to start or fund other business operations is tougher than it should be. But even when you have an appealing idea and money is not a problem, you might be tasked with deciding between accepting a loan or equity sales. It can get daunting, fast. On one hand a business loan will require you pay interest on it, which can be quite high sometimes. On the other hand, taking on an investor means giving up part of your business, which might not be what you want in exchange for business funding.
But choosing between a loan and equity investment becomes a choice you have to make when you need start-up cash or additional capital to grow your business—without a pile of cash to leverage on.
When a Business Loan is better Than an Investor
Like most entrepreneurs, you’ve invested a lot of time, energy, and effort into your startup. Right out the gate, if relinquishing a share of your company is not an option you like, taking a business loan makes sense.
All a lender needs you to do is to consistently payback the nation 21 loans in time. So if your business has a healthy cash flow or have sufficient collateral, you might prefer to pay interest over selling equity. A business lender has no other vested interests in your business and you are in control to run it as you envisioned earlier.
When you clear the debt with a debt financier, your relationship with them is fulfilled. You can decide to look elsewhere if you need more financing or reapply with them again. That’s if you have been paying consistently and timely; and you’d have built your credit profile to qualify for better terms. Once an investor signs up to co-own your company, you are stuck with them until they recoup their initial investment and a chunk of profits.
Moreover, if looking to obtain finances for a small business, taking out an SBA loan can offer a more affordable financing option than many equity investment offers. It is not uncommon to obtain debt capital at 15-18% per annum, while investors demand an average of 25% per annum in return on investment (ROI). Also, with a lender you are assured there will not be changing terms of contract to surprise you later on.
That being said, a loan comes with specific obligations outlined in the loan contract. You can go over the fine print with your legal adviser before signing on the dotted line. But an equity investment relationship can change with time, sometimes in your investors’ favor and detriment to your life’s work. Still, it is not uncommon to have investors vote the entrepreneur out of control and take over the business after a while. You do not want that.
But are investors all that bad?
When an Investor is better Than a Business Loan
Additionally, you probably already know how tough it can be to qualifying for a business loan when you are new or your current financial position is not appealing to a lender. An investor looks at your vision and figures if your business has growth potential. Even when your financial position is less than welcoming, an investor can inject capital when you need it most. It is common knowledge, being an entrepreneur requires risk. But no risk, no reward right?
Qualifying for a loan requires you to secure it with collateral, often that means putting personal property on the line. This is a huge risk that might be costly if the business is unable to repay the loan in the future. With an investor, you are not obligated to pay a dime if the unexpected happened and crumbled your business. This could happen even before they could recoup their initial investment. No collateral necessary. No personal property to sacrifice.
Still, for most startups a loan can run the new business into bankruptcy fast. While a lender requires you to start repaying the loan soon after take out, an investor is usually willing to sacrifice short-term profits, allow time for growth, and can even pump in more funds to ensure you become profitable. And, perhaps one of the major reasons you’d want an investor over a lender, the former usually offers a wealth of business operations experience, connections and marketing buzz. These “side-benefits” may prove extremely resourceful when you are just starting out, dealing with new markets or charting operational issues.
In any of these cases, an investor acts as both a business consultant and a financier—a rich offer compared to the hands-off approach a lender employs.
In conclusion, it all depends on what you consider more important for your business at the point of financing. If you need a partner who will provide both personalized business advice and money, you might want to choose an investor vs lender. But if sharing your company to others, who might make making decisions more frustrating and cumbersome than you’d like, taking out a business loan would make more sense.