If you are running a business, chances are you will need to add some more capital at some point to scale up or sometimes even just to survive. It could also be that you want to expand your business or finance some of the key operations. You can consider taking a business loan or finding an investor to fund your business, but you will likely contend with choosing between the two because the two are double-edged swords with pros and cons.
There are many factors that will come into play, and you will need to weigh them against your business needs to determine whether you’re making the best decision. Let’s discuss the pros and cons of getting a business loan and finding an investor to help you make an informed choice as you plan to finance your business.
Getting a Business Loan to Fund Your Business
It is not hard to get money from a bank, provided you are eligible. The bank will need to ascertain if you are capable of repaying the loans. They will look at your past performance to assess the stability of your business. Lenders may want to know how your business is likely to perform in the future and the financial health of your business in general. Here are the key things the lender will look at before they approve your business loan.
One of the key areas your bank will focus on is the cash flow of your business. The lender wants to ascertain whether your business can generate a steady income over time. The lender may also want to know your revenue streams as well as how you spend the money. They might need to look at your income statements, cash flow statements, and projected income. The amount of money the bank will lend you is likely to be proportional to the financial standing of your business.
Some banks may want the loan secured by collateral, especially if the bank thinks that your income alone will not suffice. You can use a vehicle, property, or other valuable assets as collateral depending on the amount of loan you want to take or the bank’s policy. If you have valuable collateral, you stand a good chance of securing a loan.
Some lenders will be more comfortable lending money to businesses that have shown resilience. They would want to satisfy themselves that you have enough experience in the industry. You could therefore be asked to provide your personal and business resumes. You will need to therefore demonstrate to them that you are capable of managing your business well in order for them to have confidence in you.
You could be required to furnish your bank with a business plan outlining how you intend to run your business. A business plan will show the scope or nature of your business, past performance, financial projections, and other key operations. It will help your lender have a good picture of your business and enable them to assess how much you can qualify for.
Pros of Taking Business Loan
Sole Ownership of Your Business
Once the bank lends you money to finance your business, they do not have the right to control it or partly own it. Once you pay them back, you will retain full ownership of your business. Investor funding is a different kettle of fish as the investors will partly own your business.
You are the Sole Decision Maker
Lenders do not have the right to meddle with the running of your business. When you borrow money from a bank, you will continue to make your own decisions without interference from the lender. If you choose getting investors, they would have a part in the decision-making.
Enjoy Profits Alone
When you take a bank loan, you do not share profits with them as an investor would. Have you had a bonanza or made a killing in your business? The beauty of a business loan is that you will enjoy the money alone.
Cons of Taking Business Loan
Difficulty in Acquiring a Loan
If you are just starting up and your business has not stabilized, it may be difficult to secure a bank loan. Unfortunately, many financial institutions do not buy mere promises. They want to see the track record of your business to assess your ability to pay the loan.
Loan Interest and Penalties
You will not run away from interest if you want to take a bank loan. Some banks charge insane interest rates, and you could end up paying twice or thrice the principal amount. Some banks may penalize you for not paying in time. It is always advisable to understand terms and conditions, particularly applicable effective interest rates and other hidden charges.
Lenders may require you to secure the loan with personal or business assets. Ideally, the collateral should be worth your loan, so in the event, you default on your loan, they can liquidate the asset to recoup their money. If your business doesn’t have a valuable asset, you would need to put up personal assets.
Risk of Losing Personal and Business Assets
If you are unable to pay, the lender has the right to confiscate your assets and dispose of them to recover the money. If the business assets are not enough to fully cover your debt, they can as well liquate your personal assets.
Investors Funding Your Business
Investors finance money in other people’s businesses with a view of earning interest or return on investment. They can pour money into your business or have an equity stake.
Investors would like to see whether your business is a good fit for their investment. They would want to assess whether a capital injection would catalyze the growth and profitability of your business. Here are a few things they may be interested in looking at to aid them in making the decision.
Investors want to understand your business idea, your products or services, and market analysis. They want to understand the market and business environment in which you are operating to assess whether a possible capital injection would help increase the fortunes of your business. A pitch deck is a well-thought-out plan mapping out strategies you want to employ to reach your goals. It also lays out financial needs that would help your business achieve its objectives.
Owner’s Competence and Involvement
Very few people would want to invest in businesses whose management doesn’t have the requisite competence. Investors want to satisfy themselves that the owners or the people charged with running the business are capable. If you want to get funding from an investor, you have to demonstrate to them that you will be at the top of your game in steering the business forward.
Growth Potential of Your Business
The reason why some investors choose to invest in startups is that startups have growth potential. Venture capitalists are usually very particular about this element of a business. They want to invest in businesses with high growth potential because they have a high return on investments in the long run. If your business shows an impressive growth trajectory, investors will be more than willing to finance it.
Share of Equity
Investors want a stake in your business or a percentage of the owner’s equity. The share of equity will be commensurate with the amount of money they will inject into a business.
Pros of Getting Investors
If your business is performing well and needs more funds, existing investors can inject more money in exchange for a higher stake.
Not Obliged to Repay Money if the Business Fails
Investors inject funds into a business out of their conscience and the perceived risk. They invest aware of the associated risks of investing in the business. They understand that the business can do well or fail. If the business fails, you are not under any obligation to pay them unless there is an explicit agreement in the contract.
No Monthly Payments or Interest
Unlike a bank loan, you are not required to make monthly payments. Investors are paid quarterly, semi-annually, or annually depending on the company’s policy or agreement.
Advice from Investors
Some investors offer invaluable advice, which can help you in running the business better. If you feel you don’t have much knowledge or experience in a particular area, you can consult them.
Cons of Getting Investors
You have to Cede a Share of Your Business
Investors invest in your business because they have a financial interest in it. In return, they want a share of the equity, which in effect means that some of your profit will be going to them, and they may be taking part in decision-making.
Investors will Have a Say in Running Your Business
You cannot make unilateral decisions since investors are deemed to own your business partly. Since investors have a stake in your business, they will not just let you make decisions that are not healthy in their eyes. This makes the decision-making process to be long and frustrating to the owner.
Sharing of Profits
If your business becomes successful and you start making a killing, you will not be able to enjoy the profits alone because you have to give investors their rightful share of the pie. Depending on your shareholder policy or agreement with your investors, you could find you are channeling huge sums to them.
Which Option Suits You?
Choosing a funding option can be daunting, but you can always get professional advice from financial experts like SwiftBooks. Do your due diligence to compare the funding options available to you. Weigh the pros and cons of using either of the methods, including assessing the cost of equity or debt. You have to bear in mind that a business loan is akin to debt financing, where you are borrowing money that you have to pay with interest.
On the other hand, investor funding is equity financing, where you sell a portion of the equity in your business. Even as you look at the cost implications, you need to weigh your decision against your long-term goals, need for control, borrowing requirements, business structure, and future repayment terms.
Are you running a small business and not sure whether to fund it through a business loan or an investor? Turn to one of the trusted accounting companies in Florida, Swiftbooks, LLC. Call 786-204-2881 to request a free quote or consultation. Get a FREE trial to turbocharger your business today!