Business Loan or Equity Financing: Which One is For You?
By: JeFreda R. Brown, MBA
As a new or existing business owner, one of the most important decisions you have to make is what type of financing you want to obtain. There are two common types of financing available: debt financing and equity financing. First, you need to understand what each type is, and then you need to make an evaluation of your business to determine which type of financing benefits your business the most.
Debt financing is simply obtaining a loan. The loan can be from any available resource, such as a bank, family, friends, and even investors. There are some investors who will provide loans to a business.
Equity financing refers to obtaining funds from investors or venture capitalists. These investors may also include family and friends. Before deciding on which loan is right for you, it’s important to consider the pros and cons of each.
The advantages of obtaining debt financing can vary. One advantage is that the business owner retains 100 percent control of the business. Another advantage is the tax benefit. Interest paid on a business loan is tax deductible. Also, there is an easy exit strategy with debt equity. Once you pay off the debt, you are done dealing with the lender.
The advantages of obtaining equity financing can vary also. One advantage is that the business owner now shares the risks with the investors. Another advantage is that the burden of having needed working capital is lifted off of the business. Also, if the business fails, the original business owner may not be required to pay the funds back to the investor.
One disadvantage of debt financing is that you have to be able to pay the loan back. You have to generate enough revenue each month to make the monthly loan payments. This can cause stress for some business owners who may not have enough revenue coming in or who are having a hard time obtaining payments from customers or clients. Also, since the financial crisis in America, more lenders are requiring business borrowers to provide personal guarantees. This means that you will most likely have to provide some collateral using personal assets in order to obtain the business loan. In addition, most lenders require excellent credit as a personal guarantee of the loan.
There are some specific disadvantages to equity financing as well. In order to obtain funds from investors using equity, you have to give up some of the ownership of your company. You have to give up a percentage of your business to the investor or investors. When decisions have to be made, you have to consult with the equity partners. You are no longer 100 percent in control. If problems arise with the investors, the exit strategy may be more complex and costly. According to the terms of the agreement with the investor, you may have to spend more to buy the investor out than what you originally obtained from the investor.
Where to Find Financing
Technology has made it a bit easier to find resources for financing your business. We now live in a world of crowdfunding, online business loans, and search funds. Some popular online lenders are Kabbage, OnDeck, Prosper, and Lending Club. Microloans are also very popular for business owners who may not meet the requirements for a business loan from a financial institution. Microloans provide funds in smaller amounts that can range from $500 to $350,000. The SBA has a microloan program where they work with intermediary lenders. These lenders are nonprofit, community-based organizations.
It’s also easier now to find venture capitalists and angel investors online. Before you begin the search for a venture capitalist, please be aware that the process to obtain funds from them may not be easy and may take longer. They use pooled funds, so you are dealing with a group of investors.
In some cases, the choice of obtaining debt or equity may not be difficult. It may be obvious for a startup company to determine if they need a business loan or equity investors. Startups requiring a large amount of capital can go either way. If a business has a short-term need for capital, it may seek out a business loan. Many business owners have called upon family and friends and even used credit cards to fund these short-term capital needs. Whatever decision you make, make sure to develop a plan beforehand that outlines how you plan to pay the money back to a lender or an investor.
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