Becoming a business owner comes with a great reputation and lots of rewards in our society; you make rules, work for yourself, take home all the profits, etc. As nice as that sounds however the challenges that comes with being an entrepreneur (even from the startup day of a business) are quite enormous. Often times it is difficult for an entrepreneur to overcome 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 blossom into a successful one. 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 is very essential that you understand the pros and cons of choosing one over the other. To make the process simpler let us look at each of them.
1. BUSINESS LOAN
Business loan is a financial tool aimed at providing 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 financiers include finance companies, banks, credit card companies, credit unions and private corporations. You can also borrow money from friends or relatives. This usually comes with a more reduced interest rate than when you borrow money from other loan financiers.
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 in which you may find yourself. But generally business loans are repaid over a predetermined period of time with regular repayments. While business loans uses this fundamental structure they differ by the business loan type you may need for your business.
Types Of Business Loans
There are several different types of business loans that can help to cater to your unique business financing needs. These includes but are 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 more than likely what you are thinking about. Term loans provide your business with an agreed amount of money that will be repaid (plus interest) with scheduled monthly payments over a scheduled repayment period. While a short-term loan has a repayment period up to eighteen months, a long-term loan has a longer loan repayment period up to five 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 a long-term loan.
Line of Credit. Also known as an equity loan, a 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 necessary piece of equipment. The repayment term for this type of business financing will usually be the expected lifespan of the equipment you have purchased with the loan. 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 opt for, it is important you understand that not every entrepreneur who applies for a loan will get one. There are factors that the lenders usually evaluate when applications are made for a business loan. These include the details of your business such as 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 by the bank and
- Liquidation can be initiated under legal procedures
If you have a bad credit rating note that it may become difficult to get fund via this means and you may be required to pay higher interest rates.
2. SELLING EQUITY OF YOUR BUSINESS (EQUITY FINANCING)
Just as the name suggest, 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 anticipates that the businesses will 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 business 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 aspect 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 types of equity investors. Therefore before you enter into any agreement with an investor consider whether or not you are like-minded as they will ultimately 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 a 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 which 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 in that 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 percentage.
- 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 to know every significant detail about your business.
- Even if it is not the best for you, it is vital that 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 for 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 the more suitable choice.
- Loan Amount Provided. The amount of money you can borrow through business loan particularly as a small business is limited because lenders do request collateral as a form of loan security. Most lenders have a maximum amount they can lend businesses under different types of business loan. Approval 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 huge you should consider equity financing but if small a business loan should be your better option.
- Network. Separate and part from the financial gains you aspire to make as an entrepreneur you will also need guidance as well as access to the right connections as it pertains to your business niche. With equity funding you can get an equity investor(s) who has 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. They have not really invested in the growth and success of your business.
- Business Control. Taking a business loan restricts you as the owner of your own company without having to answer to investors. Your ownership remains intact, you make decisions alone and you are also do not have to part with any of your company shares. With equity financing there is virtually nothing you can do without the approval of your investor(s). You are accountable to them. If you are more particular about the ownership stake of your business then business loan is the better choice.
- Cost effectiveness. Business loans are generally cheaper when compared to equity financing. This is because you will only owe the principal loan amount, interest and fees and you 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 will find equity financing a mutually favorable arrangement. Otherwise you should consider a business loan.
Financing is just as important as other aspects of your business and this at times require taking calculated risks. By now you should know whether it’s a business loan or an 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 aspects.
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