Understanding Business Loans Versus Investor Equity Financing

Joseph, Director at Wise Business Plans, has overseen 15K written business plans, raising over $1Bn in funding in more than 400 industries.

In my experience overseeing thousands of business plans, I’ve learned several lessons about business debt financing versus equity financing. 

A business loan and equity financing are two different vehicles to approaching financing. Which type of funding is right for you? That is ultimately your decision, but here are some things to consider when deciding whether to seek a business loan or equity financing.

Credit History: Most lenders will want to know your credit history before approving a loan. If your credit history is poor, then you may need to seek equity financing, whether or not you prefer to do so. 

Business Model: Lending institutions usually prefer to lend to businesses with a tried and true model, such as a coffee shop or a restaurant. If you aspire to have a superior product or service offering but are not looking to completely reinvent the wheel, then a loan may be a good option for you. A loan may also be a good option if you’re looking to open a franchise with a well-established brand. If you’re looking to disrupt an industry through cutting-edge technology or a revolutionary idea, then you’re more likely to attract the interest of an investor than a lender.

Risk Tolerance: When you obtain a loan, the lender will make money on the closing fees and the interest rate paid back. The monthly payment will be determined by the term, interest rate and amount of financing received. This means that if the business doesn’t succeed, you’re still responsible for paying back the loan with interest, which equates to you having a higher risk of bankruptcy if this scenario happens.

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Equity financing is different, though, because the investor is investing capital in exchange for a percentage of ownership in your company, which would equate to a predetermined number of shares. The investor is hoping the value of those shares will increase over time and lead to a substantial return on investment (ROI). However, while circumstances may vary depending on the terms you negotiate with an investor, the investor is usually assuming the risk of non-payment if the business fails, meaning you don’t have to pay the investor back.

Assets To Be Acquired: Lenders usually prefer to issue loans for businesses that will use much of the loan to procure tangible, depreciable assets. The reason for this is that if the business fails, then these assets can be liquidated and the proceeds used towards paying off the loan (remember, if the business fails, you’re still responsible for paying off the loan). Lenders may still be willing to loan money despite having little or no depreciable assets, but you may consider seeking an investor if this is the case.

Collateral: Along the lines of risk tolerance, another factor to consider is what personal assets you are able and willing to put up as collateral and risk losing if you obtain a loan and the business doesn’t succeed. If there is still a balance on the loan after liquidating the business’s assets, then your collateral is next in line towards paying off the loan. If you obtain equity financing, then you typically don’t have to worry about collateral, unless you negotiated otherwise with the investor.

Control Of The Business: While this isn’t related directly to the funding, another factor to consider is how much, if any, control you are willing to give up as you launch and grow your business. If you obtain equity financing, then the investor will often want a say as to what the company’s goals will be and how to achieve them, and since they are a part-owner, you may need to be willing to negotiate. Since a lender doesn’t own any part of the company, you are more likely to maintain greater control over your business goals and how you plan to reach them.

As you can see, business loans and equity financing both have advantages and disadvantages. If you carefully consider each of the points mentioned above, you’ll be in a better position to decide for yourself which route is better for your business and your business plan.


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