If you want to start your own business, you need to have capital. Unless you already have money saved up, getting capital requires you to either take out a business loan or to secure equity investments. The type of business you plan to open and your credit score will help to determine which option is best for your needs.
Business Loan vs. Equity Investment
A business loan will create debt that you will need to repay over a specific amount of time. You will also have to pay interest. Business loans must be used for your business and cannot be used in your personal life. For example, you can use it to renovate your business, but not your family home.
A business equity investment is money the shareholders invest. This money isn’t returned in the normal course of business. Instead, it can only be recovered when investors sell their shares or when other assets are liquidated and distributed among shareholders.
Advantages and Disadvantages of a Business Loan
If you take out a loan that is only in your name, you will remain the only person running your business and retain complete ownership and your lender will not receive any portion of your profits. Because a loan requires you to pay it back in regular monthly payments, it is easier to keep track of than if you were to account for your profits with an equity investor. When paying a loan, you can deduct interest as a business expense on your taxes each year.
Business loans have several disadvantages, too. The interest means you’ll be paying back more than you borrowed. In addition, if you don’t have a solid credit history, you might have to provide collateral to secure the loan, or you might not be able to get one at all. You will still have to pay back a loan regardless of how successful your business is, and if you don’t pay it back, the lender can sue you.
Advantages and Disadvantages of an Equity Investment
If you need a large amount to get your business up and running, an equity investor is more likely to be able to provide the money. Banks are not known to loan very large amounts of money. In addition, the terms for repaying an investor are often more flexible than those for paying a loan lender. Some investors are great businessmen and women themselves and are willing to provide mentoring. Investors also understand that businesses fail sometimes, so you usually will not need to pay back an investor if your business doesn’t thrive.
Despite the more flexible payment options that come with equity investors, it isn’t the right choice for everyone, especially if you do not want to answer to other people when it comes to how you run your business. Investors usually want to have some say in the daily operations of your business by being part of its board of directors or simply overseeing how you operate. You will also need to consider the type of investor you want to work with. For example, if your business doesn’t deal with science or technology, you aren’t likely to interest venture capitalists, as they are interested in businesses that have the potential to provide huge returns on investments. Finally, not only will you likely pay out more profits when working with investors, but because they have legal rights regarding how you run your business, they can sue you if you violate those rights.
Opening a business using a loan or equity investments really boils down to your own personal needs. If you prefer to be the sole voice in your business, it is best to pay off a loan over time. If you don’t mind collaboration, equity investment can save you lots in interest and might be the way to go.
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