It takes money to make money, whether it’s buying inventory, renting equipment, or paying salaries to employees. Most small businesses need financing at some point in their growth trajectory, and determining how to secure that capital is an important business decision.
The two main ways to secure business capital are business loans or equity financing. These options are distinctly different. With business loans, you retain all ownership and decision-making power in your business and simply repay the loan, with interest, on the terms of the lender. With equity financing, instead of borrowing money that will have to be repaid, business owners give up some control or ownership of the business and take on a financial partner.
Each type of financing can be the right decision for various businesses. To determine what is the best way for your business to raise capital, consider asking yourself these five questions.
Is your business attractive to investment companies?
Equity financing is only available to companies that attract stock companies – and they are generally attracted to strong finances, promising business plans and dynamic leaders. To build an equity financing case, you need a solid valuation and valuation of your business that includes future growth expectations, management team capability, debt level and other details. It’s a good idea to use an external auditor to assess your business to present an unbiased assessment.
Additionally, you will need clean financial documents and a solid business plan. Finally, most investment firms are as much about the people as they are about the companies they partner with. So ask yourself if you can exhibit a dynamic personality, passion and leadership style.
Do you want to keep control of your business?
In most cases, private equity firms will require some control of the business in exchange for funding. In some cases, you may be able to retain some management control for a while, but ultimately the partner will usually take control.
With a business loan, on the other hand, you will be able to maintain control and make all business decisions. You will only have to repay the loan over time.
It is important to honestly assess whether it is acceptable to give up some control of your business to access financing. If retaining full management control is a priority for you, a business loan is likely to be the best choice.
Are you interested in reducing your stake in the company in exchange for financing?
In addition to giving up complete control or management, accepting equity financing usually means that you will also be giving up some ownership of your business. If you are considering this, determine how much ownership you are willing to give up in exchange for the capital.
For example, you may be able to negotiate to retain a majority stake for a lesser amount of capital. However, if you’re determined to retain full ownership of your business, a business loan is probably a better fit for your capital needs.
Do you want to bequeath your business to children or other family members?
Many business owners dream of leaving their business as a legacy to their children or other family members when they are ready to leave day-to-day management behind. When new managers are equally engaged and passionate about the business, this plan can be rewarding for all parties involved.
However, if you accept equity financing and relinquish control and ownership of the business, you probably won’t be able to pass your business on to family members. Instead, the financial partners will decide who will take your place when you are ready to exit.
With a business loan, however, you will retain ownership of the business and can leave the business and its assets to whomever you choose. You will just need to arrange the repayment of the loan over time.
Do you need temporary financing or long-term capital?
Equity financing is a long-term solution that changes the makeup of your business. For example, financial partners are likely to exercise some control over the management of your business and have a say in business decisions. In return, they will provide long-term capital and may be able to provide additional resources and information to help grow the business.
A business loan can be a short or long term solution, depending on your needs. Some business loans have a specified repayment term, such as 10 years, while others are set up as lines of credit, which can be available whenever you need them.
Determining the right option for business capital will depend on your appetite for long-term change and loss of control of your business, and answering these five questions can help you make a decision.
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