Editor's choice: SmartBiz
- Large network of SBA lenders
- Low potential APR
- Loans from $30,000-$5 million
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You’ve got the plan, you’ve started building your business — maybe you’ve even gotten family and friends to buy in. Now you need to put those big plans into action, but bootstrapping isn’t an option right now.
That’s where business loans and investors come in. Whether it’s a venture capitalist, an angel investor or an investment corporation, there are pros and cons to investors — some of the same ones as business loans. Read further to learn just what you’re getting yourself into with either option and how to weigh which might be better for your needs.
How do business loans differ from investors?
There’s a good deal of differences between business loans and investors. First, let’s define an investor. An investor is a person or organization who provides funding for your business in exchange for a share of the company, with hopes that they’ll get a return on their money. You’ll have several types of investors to choose from. No matter which you choose, you’re indefinitely giving up a slice of your company’s value — called equity — in exchange for funding.
A business loan, on the other hand, gives you financing that you pay back. You will not be required to give up equity in your company. If you’re applying for a secured loan, you will typically provide collateral. But letting a bank put a lien on your equipment is a lot different than giving up ownership of a part of your business.
What are the benefits of business loans and investors?
Business loans
- Repayment. Once you repay the amount of the loan and interest, you’re free of your agreement with the lender. Get a fixed-term business loan with predictable monthly payments With a fixed term business loan, you’ll also know the exact amount you’ll repay over the life of the loan.
- Retain ownership. You get to keep the same ownership over your business as when you started the loan.
- Simple relationship. With a lender, you simply take out the loan and repay it. No strings attached.
- Specialized funding. If you run a small business, you can potentially qualify for an SBA loan with even lower rates.
Investors
- Potential for additional funding. By taking on a share of your company, an investor takes on stakes in how well it performs. If your business needs more funding to succeed, there’s a possibility the investor will be willing to put more toward it — within reason.
- Personalized guidance. A business investor may have with industry knowledge that could benefit your company growth.
- No strict business age or revenue criteria. You may be able to get an investor on potential alone. With a good pitch, you could spark investors’ interests before your business starts making money.
What are the drawbacks of business loans and investors?
Business loans
- Difficult to acquire. If you have a startup without much business credit or revenue to show, it may be tough to get a lender to fund you.
- Can be restrictive. You may be approved to use the funds for certain purchases only.
- Personal credit considered. Even if your business is doing well, you could be denied a business loan based on your personal credit.
- Collateral. Security in the form of business or personal assets may be required. If you default on payments, that means foreclosure on those assets.
Investors
- Ownership. It’s entirely possible to lose the majority of ownership of your business if your equity is diluted by investors.
- Relationship. When something is personal, there’s a higher chance of something subjective creating a divide. If an investor doesn’t like a business choice you make, they can pull out.
- No end date. When there’s no exit plan, there’s no foreseeable point at which you could gain back the ownership you surrendered.
- Long-term cost. If you decide to sell your business down the road, your investors will need to get a payout based on their equity percentage. If you give out dividends to investors, a percentage of your profits could be diverted into the pocket of your investor indefinitely.
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Which borrowing option is better suited for me?
Whether one type of financing is better for your business than another largely depends on factors that include whether your business is new, how much of your company you want to control and whether your investor can bring anything to the table outside of funds.
If you value having complete ownership of your business, a loan could be better suited for you because the lender charges interest while you retain full equity. On the other hand, if you’re looking for an investor that can also be a source of guidance as you learn the ropes of your industry, giving up a little equity might be worth it to you.
Bottom line
Financing your business is a huge decision. When it comes to choosing a business loan over an investor, it’s important to compare your funding options to make sure you’re getting the best value. If you choose to seek an investor, you have many options including family and friends, angel investors and investment corporations.
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