When it comes to raising money for your startup, there are several ways of doing it. However, out of all startup funding options, the two most popular methods are Loan and Equity. Both types of loans are very different from each other, and sometimes it becomes challenging to choose the right option for your business. In this article, we will have a look at these two funding options in detail. Business loan vs. equity financing; know how to fund your startup.
What is a Business Loan?
A business loan involves borrowing money from a lender and returning the money over a period of time with interest. Mostly, business loans are taken from banks or a Non-Banking Financial Company (NBFC). Bank loans are the most popular method of raising funds for your startup as it does not include parting with any shares of your company. Thus, your ownership remains intact.
Also, with loans, you have the flexibility to use the borrowed money for any purpose. Many different financial organizations offer different types of loans that can be easily tailored to meet your specific business needs.
On the other hand, raising money for your startup through business loan has many potential downsides as well. The first thing that must be kept in mind before opting for a business loan is that you need to make repayments every month. Any default on repayments can prove to be a very costly financial mistake. Additionally, in case of a default, the lender can seize your assets. Lastly, if your credit score isn’t good, you may find it little difficult to raise money through a loan or might have to pay a higher rate of interest.
What is Equity Financing?
Equity financing is a process that involves selling the shares of your business in lieu of money. Selling or trading shares is another popular way to fund your startup, in which you offer ownership in your company in exchange for the capital to grow. The transfer of capital for ownership can take place with a single investor or a group of investors.
This type of financing is most suitable for businesses who are in their growth stage and do not have a lot in terms of physical assets. In this case, the investors bet on the company’s growth and hope to make money out of it at a later stage. One of the most significant benefits of equity financing is that it does not involve any monthly repayment.
Thus, you do not have to set aside a specific amount of money every month to return to the investor. Even if your business shuts down, you are not liable to pay any money. It will be considered a loss for the investor.
On the other hand, the investors don’t simply walk away from your business after offering the capital. In fact, in most cases, the investors have an active role in mentoring you through building your business. They become part owners of your business and will subsequently have a word in how you run it. So, if you opt for equity financing, you must be confident about the investor you choose. A great investor can help you realize your business goals, whereas an unknowledgeable investor can derail you from achieving what you set out to do when you established the company.
There are some other factors that help to determine the route you should take to raise fund for your startup. These include:
How much time you have
There is no doubt that equity financing takes a lot of time and effort. Right from the paperwork and disclosures to making all the legal arrangements, the process may take up six months.
On the other hand, the time needed to raise funds through a business loan takes relatively less time. Many financial and non-financial institutions help in passing a loan within a couple of days. So, if you have less time on hand, you should opt for a business loan.
The amount needed
For startups, sometimes raising a large number of funds through loans is not possible. This is because many lending institutions have a cap on the maximum amount you can borrow. Also, startups generally do not have too many assets and lenders, on the other hand, ask for collateral as security. So, in this case, equity financing can be a more feasible option. Investors can help in raising large sums of money if they have faith in your business plan.
Sometimes, startup entrepreneurs are not only looking for money but also guidance and mentorship as well as the exposure to make relevant business connections. With equity funding, you can come across a partner who has substantial expertise in your field of business. He can open doors for you and help you expand your business horizon. In contrast, a money lender is only interested in getting his money and interest back and is not at all vested in your business’s success.
With the aforementioned factors in mind, you can decide upon the best funding raising options for your startup.