This article was last updated on October 17
With the economy and unemployment the way it is today, many folks are thinking about starting or growing their own small business. But this requires money to pay for things like employee’s salaries (you may be the only employee), offices, supplies, marketing and more. Entrepreneurs typically get their money from a range of sources including government grants, business loans, investors, personal financing or venture capital. Business loans and venture capitalists are the two most common ways to fund a business. Many business owners often debate over whether a loan or venture capital is the best method to fund a business, so let’s try and shine a light on what one suits you best.
Loans allow business owners to secure a certain amount of money based upon the business idea. This money must be paid back to the lender within the specified period of time, with interest. The challenge for the entrepreneur is proving the viability of the company to pay the money back within the specified period of time. Since the economic recession, however, lenders are more reticent about lending money to businesses now than they have been for decades. So before you start the loan application, consider if it is actually the best means of funding your start-up.
The Benefits and Advantages of Financing a Business with Loans
- Loans are desirable because business owners retain full ownership of the company as long as the loan is paid. The business owner does not have to answer to investors and may steer the direction of the company in any way he or she prefers.
- All profits of the business will be distributed according to the Chief Executive Officers and other officers within the company. The loan may be used in any way to help the business without seeking the advice of the investors.
- Profits will not have to be shared with investors.
- Business owners are more motivated to promote their business if they have a loan to pay.
- New business owners may not be able to turn a profit if the business does not perform. Therefore, the business may have difficulty paying the loan on time, threatening the business’s very existence.
- Interest will accrue on the amount borrowed, and rates can be high. Venture will not require an interest payment, only partial ownership.
- Many business loans require some form of collateral in order to secure the loan, which could be anything from your home to investments. Business owners will still be responsible for the loan even if the business fails.
- Business owners with poor or non-existent credit may have a more difficult time obtaining a business loan.
Venture Capital investors will provide significant sums of money for a stake in the company. A typical venture capitalist may require a portion of the profits, a position on the board or a certain number of shares within the company before providing financial backing. However, you get a lot in return, least of all access to their network of industry contacts.
Benefits and Advantages of Financing a Business with Venture Capital
- Venture capital investors may be the best or only plausible course for entrepreneurs who require a larger round of funding.
- Venture capital allows investors to express their ideas about the future of the business. These individuals have a vested interest in the success of the business, because they would like to see a return on the investment. Therefore, the advice they give tends to be incisive and truthful.
- Investors tend to have vast business experience, extensive networks and can mentor entrepreneurs in the art of growing their business.
- Investors will often become a part of an individual’s board of directors.
- If you and your investors have a disagreement, the business may also experience difficulties until the problem is resolved or the business partnership is severed. This can pose all manner of problems in the day-to-day running of your business.
- Business owners with ideas for small businesses may find it more difficult to obtain access to venture capital.
- Managing the business’s finances may be a very complex process. Having investors may make the process more complicated than some business owners desire.
Business owners must determine whether a business loan or venture capital will best suit their business needs. Small businesses are more qualified for business loans through lenders (and support from the small business loan administration program). There are several new government initiatives that will help small business owners retain loans. Some of the loan amounts are matched by the lenders or banks. If you desire to retain ownership of your business and the business idea has not fully developed, then a business loan is the better choice for you.
However, if the business plan is such that the company may involve complex software development and product development, then venture capital may be the best source of funding. Investors will review your business idea and determine the viability of the idea. Many of these ideas are carefully scrutinized. Therefore, business owners must be prepared to defend the idea. Business owners must be prepared to negotiate with investors throughout the duration of company.
Business owners must decide which option is more viable. Both funding methods have advantages and disadvantages depending on your business requirements, so often it simply comes down to deciding what disadvantages they would prefer while funding their idea.