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Business Loans vs. Equity Investments

There are essentially two different options for entrepreneurs seeking capital to start or propel their business: taking out business loans or seeking out and securing equity investments. There are advantages and disadvantages that accompany both strategies. Generally, the two options are each suited for different situations, and more often than not picking the wrong one can be catastrophic for not only your business, but your personal wealth and security.

Taking out loans for your business is more generally suited for the needs of smaller enterprises. Banks are often skeptical and hesitant to loan large sums of money for fear of defaulting. Often banks will require some sort of collateral on personal property in order to secure the loan, and even if the loan is unsecured by personal property, defaulting could potentially result in being sued by the lender. As is with all loans, there will be interest, which means the amount paid back will ultimately result in being higher than the original loan amount. Moreover, if the business fails, the loan must still be paid back in full, plus interest.

Those may seem like too many disadvantages to even consider a loan as a viable option, but there are certainly advantages that heavily tilt the scale in favor of loans over equity investments. The main advantages have to do with retaining sole ownership in the business and the day-to-day functions and the ensuing freedom. If maintaining sole ownership and decision making is important, then loans are much more beneficial than securing equity investors. The lender does not have a claim to any portion of the profits the business makes or any say to its operation. Additionally, as the business owner, the money from the loan can be used in any way you see fit. The interest payments can also be written off as a business expense. Maintaining this freedom is extremely important to many small business owners, making loans a viable and preferable option.

Equity investments are more realistic options for larger ventures. Banks are often leery of loaning out extraordinary sums of money, whereas many venture capitalists and other investors are willing to buy into ideas they deem as potentially successful. Another advantage over a bank loan is the personal aspect of these investments. These investors are much more inclined to be directly involved in securing the success of their investment, meaning that there are more people on your side doing whatever they can to propel the business to success. Additionally, these investments could potentially lead to a mentoring and business advisory network that would otherwise be non-existent. There is also the reassurance that even if the business fails, you will not have to repay your investors (barring any criminal activity within the business).

The disadvantages of these types of investments are exactly the contrary to the advantages of small business loans. Namely, losing shares of profit and decision making in day-to-day operation. By definition, an equity investment exchanges a portion of control or shares of a business for whatever dollar figure is agreed on (for example, a business valued at $7,000,000 seeking a $1,000,000 investment would be expected to relinquish approximately 15% of the business shares for the investment). This means that instead of retaining 100% of the business’ profit, you’d only retain 85%. Investors also retain legal rights in respect to management of the business and could potentially sue if these rights are violated.

The two options are essentially two opposite ways to achieve the same thing: capital to propel business. Business loans allow freedom and complete control, along with exclusive claim to the profits earned by the business. However, these loans are usually only an option for those businesses seeking minimal amounts of money, and could potentially destroy your personal life. Conversely, finding and securing investors could provide a maximum amount of capital and success, but limits personal profit and relinquishes at least partial control of business affairs. Both are viable options, but should be carefully considered before deciding between the two.

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