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Knowing the differences between taking out a loan and bringing in an equity investor are essential to choosing which is right for you.
Small businesses seeking capital basically have two optionsfindingbusiness loansor securingequity investments. Determining which is better for your business will depend upon the type of business you own, your credit worthiness, and your willingness to have someone looking over your proverbial shoulder.
You maintain complete ownership of your business and remain the only voice in running it.
The lender doesnt get any portion of your profits or say in the business.
Managing your finances for loan repayment is easier than accounting for profits with an equity investor. With a loan, you will have regular monthly payments for a fixed period.
Interest payments can be deducted as a business expense.
You can use the money from a business loan in any manner you see fit.
If you need it, repaying a loan is a terrific motivator to working extremely hard for your business to succeed.
You have to pay interest on the loan, so youll be paying back more than youve borrowed.
If you havepoor credit, you may not be able to get a loan.
You may have to provide collateral on personal property in order to secure the loan.
Even if the loan is unsecured by personal property, if you default on the loan, you may still be sued personally by the lender.
If the business fails, you still have to pay back the loan in full, plus interest.
Investors may be better suited to provide large sums of capital. Banks are leery of lending very large sums because of the risk of default.
Repayment terms are more flexible than that of business loans.
Depending on the investor, you may have a built-in mentoring and business advising network to help your business.
Because they have equity in the business, you have people who are interested in the business succeeding and will help you in this goal.
If the business fails, you typically dont have to pay back investors (in the absence of any fraud, of course).
You may lose full control over the direction or day to day operations of your business. Investors may want to be part of theboard of directorsand oversee operations.
Venture capitalists typically invest in businesses that have the potential to offer huge returns on their investments (i.e., software companies, scientific inventions) and are generally uninterested in most small businesses that dont forecast huge potential growth.
You may have to share a larger portion of your profits with equity investors.
Investors retain legal rights with respect to the management of the business and have the right to sue you if these rights are violated.
Many people hear the term venture capitalists and assume that these investors will be interested in becoming equity investors in their business. However,venture capitalistsare like any large investor and are seeking a large return on their investment. Therefore, venture capitalists are uninterested in most small businesses, which generally seek to turn enough of a profit to make a comfortable living for the owner and employees. Unless your business projects huge potential profits (for example, you have a restaurant that you think has potential to be franchised or you have an invention youre working on and need capital for research and development), forget venture capitalists.
What you may be seeking is an angel investor. Angel investors (the name comes from an old term describing investors in Broadway productions) also seek a return on their investment, but their goal in investing is sometimes more altruistic. Often, theyre wealthy entrepreneurs who want to share their knowledge and help businesses get off the ground.
Information on angel investors isnt as detailed as surveys of venture capitalists or traditional lenders, and its often difficult to tell the difference between a regular business investor and an angel investor (an angel investor could also be a family member or friend), but according to the Small Business Administration, they are out there, and they are investing in the success of many small businesses.
Choosing Between Business Loans and Equity Investments
Ultimately you will have to determine how the advantages and disadvantages of a business loan and equity investment apply to you and your business. If your business plan projects potentially large growth, equity investors may be attractive for their lenient repayment terms, low risk (they wont sue you unless you defraud them), and business acumen.
On the other hand, if you project modest growth (i.e., you arent planning on running a large business enterprise) or want complete autonomy in making business decisions, a loan might be better for you.
Whichever option you choose, be sure to carefully contemplate the pros and cons of a loan or equity investment, and you will be able to make a well thought through decision.
Let an Attorney Help You With Your Business Financing Decisions
Not sure what the next step should be for your business? If you are considering an equity investment or a loan, you should learn all you can about the law and the obligations that come with these courses of action — as making the wrong decision for your business can hurt your chances for success. You can learn more about your situation by meeting with asmall business attorneyin your area today.
Contact a qualified business attorney to help you address the finances vital to your business.