Almost anybody runs the other way when you mention the word “debt,” but sometimes it’s a good idea to understand how to use it to your advantage. Borrowing money instead of seeking additional investment capital to finance operations and growth can be healthier for your business long term.
Let’s uncover the investor vs. loan options available to find out which is better for your business.
A loan is when you borrow money from an outside source or an individual and agree to pay it back on a certain schedule with interest.
- Loan debt is flexible and terms can be set up to match your specific needs.
- Loans don’t dilute an owner’s equity in the business, and lenders don’t have any stake in the business.
- This type of debt won’t have a lasting impact on your company after you’ve repaid the loan.
- Interest on loans is tax deductible. Many business owners don’t think about this when considering taking out a loan for growth demands.
- Loans are fixed obligations that must be repaid, regardless of the financial position of the business.
- Loans raise the break-even point of the business, so you’ll need more sales to reach profitability.
- Loan agreements could include restrictions on certain business activities and require some assets of the business to be pledged as collateral.
- If the loan has a personal guarantee, owner could face personal losses in the event of a default on that payment.
When you raise investment capital from outside parties, you’re giving up partial ownership of the business and a share of future profits.
- You don’t have a binding obligation to pay dividends to investors.
- If the business fails, you don’t have to repay the investors.
- You gain valuable insight from investors who have experience and industry connections that can significantly increase the value of your business.
- The business owner must give up a portion of equity in the business.
- Equity costs more than loans because investors assume more risk.
- A business investor may want more control of business management decisions. Tensions could arise in that process.
When deciding between investment capital or business loans, you may want to consider how each will impact the short term. intermediate, and long term capital needs of the business. As Forbes points out, the key differences between debt and equity are about ownership, control, and costs.
Business owners tend to start their own businesses because they want independence and control. They want to own all of it and to enjoy the rewards of their hard work and effort. Why share the profits with an outside business investor when you’ve done all the hard work? Typically, in most cases, you will be giving up at least half of your business in an equity position.
Alternative lenders don’t want to be involved in every hiring decision or marketing strategy discussion; their main priority is to be repaid on the money they are letting you borrow. You can spend more time running your business rather than trying to placate the inevitable questions from investors. Lenders won’t tell you how to run your business, they just provide you with the capital to do so.
Debt allows owners keep most or all of the control, whereas equity takes some control away.
Interest on debt is usually less expensive than the required return on equity. Investors often demand a higher return on their money because they have no guarantees they’ll get their money back. Lenders, on the other hand, often have fixed plans of repayment and less risk seeing as certain loans can be backed by collateral (Receivables, Equipment, Real Estate, Stocks).
Lenders offer a variety of different kinds of loans to meet any type of cash flow need that small business owners face. For instance, you can get loans for short-term working capital to finance seasonal growth. And on the other hand, you can get long-term loans to purchase equipment to increase production and open up major profitability vessels. With a well-thought-out plan and accurate cash flow projections, you should be able to finance the growth and expansion of your business without ever having to give up any ownership.
After the loan has served its purpose and is paid back, your liability to the lender is over. The lender has no further claim or involvement in your business. When you have investors, they’ll have partial ownership and a voice in your business. This “voice” could ultimately end up drowning your business if you aren’t on the same page with the investor.
When managed properly, debt can help you keep control and not have to give up any ownership, putting you on the right path to a healthy and profitable business. If you believe in your business, keep your equity and leverage debt. You will thank yourself in the long run. Capital is always available for cash flowing businesses to use. Visit us at www.starcadecapital.com to apply for a loan and turbocharge your business.