Becoming a business owner comes with a great reputation and lots of rewards in our society – you make rules, work for yourself, take home the profits only etc. As nice as that sounds, the challenges that come with being an entrepreneur (even right from the starting day of a business) are quite enormous. Often times, it is hard for an entrepreneur to prevail over all these challenges to become successful.
A common and major problem that virtually all business owners encounter is the issue of financing. Business and finances are inseparable, as the latter plays a significant role in the smooth running of any business. Any great business idea requires the necessary financial support to bloom into a successful one. And as a business owner, there are several options available to you.
In this article, I shall be discussing the two most popular ways through which you can raise financial support for your business. These are:
- Business loan and
- Selling your business equity.
To get financing for your business, you need to decide whether you want to sell your business equity to investors or borrow money. Both works differently and it becomes essential you understand the pros and cons of choosing one over the other. To make the process simpler, let us take a look at them one after another.
Business loan is a financial tool aimed to provide business owners with the funds needed to start, enhance or expand their businesses. It is a very popular financing choice among businesses globally, whether it is a small, medium-sized or a start-up business. While the lender only charges an “INTEREST” for using their money, they do not have any say in the way you manage your business. Common business loan financers include finance companies, banks, credit card companies, credit unions and private corporations. You can also borrow money from friends and relatives. This usually comes with a more reduced interest rate than when you borrow money from other loan financers.
How Does Business Loan Works?
There are lots of potential answers to this question, all of which are right based on the status of your business and the situation you find yourself. But generally, business loans are paid back over a predetermined period of time, with regular repayments. While business loans functions using this fundamental structure, they differ by the business loan type you are looking to get.
Types of Business Loans
There are several different types of business loan that can help to cater for your unique business financing needs. These include but not restricted to new project loans, SBA loans, term loans, business line of credit, personal loans for startups, non-profit business loans, top-up on existing loan, merchant cash advances, business credit cards, online term loans, online business lines of credit, secured loan, unsecured loan, and working capital loan.
Now, let’s take a quick look at some of them
Term Loans (short term and long term loans) – Generally when you think of getting a business loan, this is probably what you are thinking about. Term loans provide your business with an agreed-upon amount of money that will be repaid (plus interest) with a scheduled monthly payments over a scheduled repayment term. While a short-term loan has a repayment period up to 18 months, a long-term loan has a lengthy loan repayment period up to 5 years. Unlike the long-term loan that has a lower interest rate of a single digit, the short term loan has higher interest rates (double digits) due to the shorter length of time wherein interest on the loan will accumulate. Despite its drawbacks, the overall cost for a short-term loan could end up being lower than the long-term loans.
Line of Credit – Also known as an equity loan, line of credit is designed as a long-term debt facility. It offers you access to funds by allowing you to draw an account balance up to an agreed limit. Line of credit is usually protected by a registered mortgage over a property.
Machinery Loan– This type of loan is available when your business requires a significant funding to purchase a piece of equipment it needs. The repayment term for this type of business financing will usually be the expected lifespan of the equipment you have purchased with the loan proceeds. The interest rate can be as low as 8%, since the lender will be taking on less risk by lending to you.
Note: Regardless of the type of business loan you want to opt for, it is important you understand that not every entrepreneur that applies for a loan will get one. There are factors that the lenders usually evaluate when applying for a business loan. These include the details of your business like the length of time you have been in business, your business finances, credit score, reason for the loan, and whether your business appears risky. If on the other hand you are approved for a business loan, also note that non repayment of your loan can be very costly.
- Your business or personal assets can be taken over by the bank and
- Liquidation can be initiated under legal procedures
If you have a bad credit rating, know that it may become difficult to get fund via this means let alone pay higher interest rates.
SELLING EQUITY OF YOUR BUSINESS (EQUITY FINANCING)
Just as the name sounds, equity financing is when you sell shares or a portion of your business ownership to investors in order to raise money. Many business owners raise equity through relatives, friends, colleagues, or customers who anticipate seeing the businesses succeed. They are individuals with substantial net worth, corporations, and financial institutions. Other sources include venture capitalists (VC), who are qualified investors willing to take risks on promising new businesses. The majority of these investors do not expect an immediate return on investment in the early period of your business. But they depend on your being profitable in three to seven years.
Equity financing is suitable for startup businesses including businesses with little to no physical assets. However, it comes with some conditions. The individual or people (investors) who provide funding for your business automatically own a portion of your business and will consequently have a say in your daily business operations. This is why you must be very careful about the kind of investors you give a stake.
Forms Of Equity Investors
Equity investors can be active or passive.
- Active investors expect to be deeply involved in every of your company’s operations.
- Passive investors are willing to provide capital but will play little or no part in managing the company
Furthermore, there can be personality conflicts in either of the two (2). Therefore before you enter into any agreement with an investor, consider whether or not you are like-minded, as they will become part of your business.
Advantages of Business Loans
With attractive interest rates and flexible repayment choices, business loans generally can give a much-needed boost to your business. Here are some of its many benefits:
- You still retain the ownership of your business just as when you started the loan.
- There is definite time for the loan repayment to end
- The lender is not entitled to any percentage in business profits or share in your company. They only have claim on the loan’s interest rate.
- As you repay your business loan, you are gradually building your credit-worthiness. This attracts more lenders and boosts your chances of bargaining favorable loan terms in the future.
Disadvantages of business loan
- Startup businesses without much revenue and business credit to present may find it difficult to get business loans.
- Even if your business is performing well, you could still be denied a business loan based on your personal credit.
- You may be committing your business to a large business expense when you borrow money, since you may need to repay your loan when your need for money is greatest.
- You can ruin your relationship with friends or family if you are unable to keep up with the loan repayment terms.
- Commercial lenders require that you pledge either your personal or business assets as security to get your loan sanctioned. The situation of your business is irrelevant to them. You just have to pay back the debt plus interest within the scheduled repayment period or face the consequence, like selling off the property to recoup the money.
Advantages Of Equity Financing
Allowing equity investors to own a portion of your business comes with its own pack of advantages and disadvantages. Outlined below are a few of its advantages:
- You utilize your cash to settle business startup expenses rather than large loan payments.
- There is no pressure to make repayments for any money raised under equity financing. This implies you won’t need to reserve some money from your profits as loan settlement.
- Personalized support. An equity investor may have detailed industry experience that could contribute to your business’s growth.
- Potential for extra funding. If your business needs more funding to succeed, there is a possibility that the investor will be willing to contribute.
- If your business collapses or goes broke, you are not liable to any repayment provided you have comprehensively explained the risks involved in the business to the investors. At that instance, it can be considered a loss to the investor and not you.
Disadvantages Of Equity financing
- Equity investors usually take a larger share of your business’s profits. Since they are at a greater risk of losing their investment, you have to compensate them for this risk with a bigger pay.
- If you decide to sell off your business, you will need to payout your equity investors based on their equity percent.
- No end date. They have indefinite access to your company’s profit
- It is possible to lose the larger part of your business’s ownership if your equity is diluted by investors.
- You share your business ownership with the investors. They will be co-owners and have legal rights know every significant thing about your business.
- Even if it is not the best for you, it is a must you take your co-owners’ interests into account when making business decisions. Otherwise, they can (and most likely will) sue you if they feel you are compromising their rights.
Comparing Business Loans And Equity Financing
- Timing – Business loans can get you money fast and easy for any kind of business needs than searching out investors. It will only take banks and other lending institutions a few days to disburse any loan. On the contrary, equity financing takes a lot of time and effort. It can take up to six (6) months to get the funds due to the complexity of the legal arrangements, formalities and disclosures. If you need urgent funding, business loan is more suitable for you.
- Loan Amount provided – The amount of money you can borrow through business loan, particularly as a small business is limited since lenders do request for collateral as a form of loan security. Most lenders do have a maximum amount they can lend businesses under different types of business loan. At times, it will be based on your financial condition. However, equity financing does not require any collateral for you to be funded and the possibilities of getting a higher funding are far greater. If your financial need is large, you should consider equity financing. And if otherwise, business loan should be your better option.
- Network – Apart from the money you would like to raise, as an entrepreneur, you may need some guidance plus make necessary connections as regards your business. With equity funding, you can get an equity investor(s) who have detailed business experience and can open business doors for you, help you make relevant connections and even guide you towards growing your business. When you opt for business loans on the other hand, lenders are majorly concerned with getting their loan principal and interest back. They have not really invested in the growth and success of your business.
- Business control – Taking a business loan retains you as the owner of your own company without having to answer to any investors. Your ownership remains intact, you take decisions alone and you are also not parting with any of your company shares. With equity financing, there is virtually nothing you can do without the approval of other investors. You are accountable to them. If you are more particular about the ownership stake of your business, then business loan is for you.
- Cost effectiveness – business loans are generally cheaper compared to equity financing. This is because you only owe the principal loan amount, interest, and fees, and retain the full ownership in your company. Conversely, equity financing is not cheap. Your investors are entitled to a share of your business’s profits for an indefinite period. If you are more comfortable sharing control of your business with partners, then you can find equity financing a mutually favorable arrangement. Otherwise, you should consider business loan.
Financing is just as important as your business and at times require taking calculated risks. By now, you should have known whether it is a business loan or equity financing that is right for your business. If you still need further assistance with your financing need, there are reputable lawyers that can help you sort through the relevant consideration.
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