Growth Finance: Choosing Between Taking Loans And Giving Equity
A business loan is a financial product which is designed to help businesses in meeting their financial needs.
A business may need the loan for expansion, working capital or other business-related expenses. For a Small Business Owner, navigating the world of business loans can be daunting when you are not familiar with the different financing options available to you.
It is therefore important to understand the nuances of business loans with a view to making informed decisions that move your business towards its goals. Whether you are involved in a startup or seeking to expand your operations, you will need valuable insights to help you make the right decision about how to fund the growth of your business.
Pros And Cons Of Taking A Business Loan
What are the basics of business loans and what do you need to know before applying for one? What are the pros and cons of business loans?
There are positives in the case of obtaining loans to grow your business.
With a loan, you maintain full control of your business because your lender does not have a stake in the ownership of your business. Your lender does not have decision-making power in the running of your business.
The repayment of your loan is predictable, which makes it easier to manage cash flow and allows for better financial planning. The repayment of your loan builds your credit and potentially opens doors to better financing terms in the future.
On the negative side, a business takes on debt when it assumes a loan. This can be a burden, especially if the business faces unforeseen challenges.
This is because the repayment of the debt is mandatory regardless of the performance of the business. Moreover, a loan typically requires a collateral asset or a personal guarantee, which could put your assets at risk in case of a default.
Furthermore, loans come with interest payments, which add to the overall cost of funding the business and significantly impact its profitability.
Pros And Cons Of Giving Business Equity
If you do not want to finance the growth of your business by taking a loan, you can decide to achieve your goal by inviting more investors by issuing equity to them.
Equity is the amount of money that the owners of a business have invested in it. The shareholders’ equity is the net amount of the total assets of a business as recorded in its balance sheet.
Unlike loans, the equity contributions of the owners of a business do not have repayment schedules. Those holding equity in the business are risk-takers who share the profits and losses of the business. If the business faces challenges, its equity owners, or investors, share in the losses without immediate financial strain.
On the negative side, giving equity in the business means relinquishing some degree of control as investors would have a say in major issues that affect the business. When a new investor receives equity in return for new funds, there is a dilution of the holdings of the existing owners, which impacts their ownership stakes and, consequently, their control of the business.
This sharing of the risk of the business also means the sharing of profits as returns for investors.
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Key Factors To Consider When Choosing Between Loans And Equity
With these distinctions between loan finance and equity finance, how do you decide between loans and equity as vehicles for funding the startup or growth of your business?
When it comes to choosing between loans and equity, either of the options can help you achieve your financial goals. But each one comes with different risks and rewards. What are the key factors that you need to consider when deciding between loans and equity?
The considerations that you need to weigh to make an informed choice include:
1. Business Stage
A startup may find issuing equity to be more attractive while an established business with a solid track record may prefer taking a loan to preserve control and maintain stability of the business.
2. Risk Tolerance
You must assess your tolerance for risk. If you are comfortable sharing control and potential profits with other people or entities, you might choose to align your preference with seeking new investors.
3. Financial Position
You should evaluate your current financial position. If you don’t have the needed collateral or interest rates are high, you may be better placed to consider the issuance of equity as a more viable option.
In choosing between taking a loan and offering equity, it is clear that there is no one-size-fits-all solution. You must assess the unique needs of your business, your tolerance for risk and your long-term goals.
You must also consider seeking professional advice to navigate the complexities of financing your business with a loan or equity.
The road you choose to travel can shape the future of your venture. Whether you opt for a loan or a strategic partner, your decision must enhance the achievement of your vision for the business. The right financing strategy will lead your business to financial success.
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Photo by Andrea Piacquadio