Investors vs. Loans – Which is Best for My Business?
Starting a new business is exciting, but expensive. You need money to make money. You have to think about how you’ll pay for rent, furniture, office equipment and supplies, legal and accounting fees, research and development etc. And that’s before you’ve even paid yourself a salary!
You have two basic options for raising money to fund your business – borrowing money, or selling equity to investors. There are distinct advantages and disadvantages of both.
Advantages of Equity Financing (Investors)
Raising money in this way means you use your cash to pay business startup expenses rather than making repayments on a loan. And if your business fails, you won’t have to pay your investors back. The main risk is on them, not you. Investors are also able to offer valuable business advice and other forms of help should you need it.
Disadvantages of Equity Financing
You will have to give up a share of your business, and a percentage of the profits. You will also have to consult with your investors before making any big decisions and may have to go with their opinion even if you disagree. Your co-owners may have the right to sue you if they feel you are compromising their rights.
Advantages of Borrowing Money (Debt Financing)
The main advantage is that the lender won’t have a say in how your business is managed (at least not directly, but they may impose some conditions on your loan), and will not be entitled to a share of your hard-earned profits. All you have to do is repay the loan on time every month. And you have the added advantage of being able to claim the interest portion of the loan as a business expense.
With debt financing, the business relationship ends as soon as the money is paid back in full, and you have no further obligation to the lender. Loans can also be short or long term, and you can, to a certain degree, structure the repayments to best suit you.
Disadvantages of Debt Financing
You are committing your business to a sizeable business expense and will have to make repayments regardless of your cash flow situation in any given month. Commercial lenders often require security for the loan, such as a property or insurance policy. Failure to then repay the loan may result in you losing these valuable assets.