Building your own startup is a craze nowadays, people in the USA with innovative ideas are ready to take a risk and start their startup once. But there comes a stage in the journey of every startup when they need huge capital to sustain and boost their business growth, and this is where they start looking for ways to get those funds.
Business loans and Equity fundraising are the two main ways to accumulate funds to start or grow a business. Since both of them have their advantages and disadvantages, as a business owner, it depends on you which one you choose.
To choose the best option from these two, you need to be aware of their pros and cons. For some people, business loans come out to be the best option while for others Funding is the best option. So, here in this article, we mentioned the advantages and disadvantages of business loans and funding. This will give you a roadmap for choosing the best one.
What Is a Business Loan?
Advantages of Business Loan
Disadvantages of Business Loan
What Is a Funding?
Advantages of Funding
Disadvantages of Funding
Business Loan vs Funding: Which One Is Better for You?
What Is a Business Loan?
A business loan is a kind of loan which you take from lenders to fulfil your working capital needs. The lender may be a bank, financial institution, or investor. They charge a fixed interest rate on the principal amount of money, after a certain period of time. Interest rates are not fixed and it varies from lender to lender. you might get a loan at a low-interest rate from any lender or sometimes you need to pay a high-interest rate depending on different factors.
Advantages of Business Loan
Flexibility for loan repayment
Paying off the existing loan amount will remove a huge burden from an entrepreneur. You’re more focused on your business growth and management when you are not in debt. Although you’ve taken a loan to fulfil the working capital need for your business, if your business performs very well and you are capable of paying the existing debt, then a business loan has the flexibility to repay the loan early.
Keep in mind that when you pay the loan early, many lenders charge a prepayment fee, which is around 1% of your loan amount. Also, you might miss the benefit of tax exemption on the interest you pay for your loan. So do your math and decide whether you should pay the loan early or not. If the total interest on the loan is higher than the prepayment fee, then you can pay the loan early and free yourself from debt.
Availability of Government scheme for loans
US Government always tries to promote businesses because they give a boost to the economy. The ways are different but the intention is the same, to promote the business. Providing loans to small and medium businesses is one of the ways the American government supports the newly born business.
In 1953, the Small business administration (SBA) was formed in USA to support small businesses in terms of capital and counselling. So you can leverage the benefit of this government scheme to easily get a loan from an SBA-accredited lender. The interest rate may vary from lender to lender based on your credit score and other factors.
Ownership remains intact
One of the most important benefits of taking a business loan is that your ownership remains intact, and there is no dilution of your equity. You have full control of your business and you’re free to take any business-related decisions without the interference of any investors.
You are the decision maker and you don’t have to share your profit with any third-party investor. So go for the business loan if you have faith in your business plan and at the same time you don’t have to dilute your ownership.
Disadvantages of Business Loan
You need to prove your creditworthiness
Everyone wants to earn some money and the same is true for lenders also. They are providing you with the money because they expect some interest in it. so to make sure that they are not giving their money to the wrong person, they see your creditworthiness.
A credit score is the one factor that every lender considers, but at the same time, they also see your assets and your past credit behaviour. Your business plan doesn’t put much influence on the lender because they don’t have to do much with your business, they only need their money back with interest. So you need to prove your creditworthiness to the lender to get a loan, otherwise, you might end up taking a loan at a higher interest rate.
Difficult to acquire a loan
Since you need to prove your creditworthiness to the lender and if your credit score and credit history are not good, then most probably your loan application will be rejected. It is not easy to get a loan at a cheaper interest rate without proper credit behaviour.
Lenders also check your assets, and if you lack in this also, then it’s very difficult to get a loan. You might arrange a loan from somewhere but the chances are the interest rate would be higher than expected.
Lenders have the first right to your assets
Finally! After so much hassle and paperwork, you get your loan money in your hand and you are now using this money to fund your business. But suppose, your business is not performing well and doesn’t meet your expectations. If you are not able to repay the loan in time, then you might be shocked but the lenders have the first right to your assets.
They have the right to sell your assets and recover their loan. So these are the few disadvantages of taking a business loan you must be aware of.
What Is a Funding?
Funding is one of the most prominent ways to raise funds for your business in the USA. You have to approach an investor and showcase your business plan. You need to convince the investor that you and your business plan have the potential to convert this startup into a giant company.
Once the investor is ready to invest in your business, then they will become a part owner of your startup by owning some equity shares.
Advantages of Funding
No burden of repayment
Equity fundraising comes with many advantages and the most prominent one is – you don’t need to repay the money you’ve raised. By giving equity shares to investors, you basically made them part owners of your company. Hence, if there is any loss in the business, it’s not only your loss but the loss of investors also. Similarly, if there is any profit, then that is not only your profit but also the profit of your investors. Since you don’t have the burden to repay the capital you’ve raised, then you become more focused on your business growth.
Guidance and help from the investor
As a new US-based startup, you might not have much experience with how this startup economy works, here the guidance and expertise of an investor will help you to accelerate your business growth. Since investors have some sort of experience in the field, their guidance and help will act as the cherry on the cake for your business.
You are the one who is responsible for your business, investors don’t only invest their money in your business potential but also in you and your faith in your business growth. They will help you with their valuable advice, but at the end of the day, it’s your business and you have to take care of it.
Increase in the valuation
Whenever you raise money from funding, the valuation of your startup increases simultaneously. The valuation of a company is the clear-cut indicator of business growth, revenue, and size. In different funding rounds, you and the investor agree on a certain valuation of your company based on how your business is performing.
If the business growth is extraordinary then you can ask for a large number of funds by diluting less equity. The higher valuation of your startup will help you in future fundraising and also provide benefits in acquisition and merger.
Disadvantages of Funding
Equity is diluted
In simple words, Equity means ownership, how much you have the right in a company. Whenever you raise money, the dilution of equity shares happens, which will decrease the percentage of ownership in the company. So you need to be conscious that you should not be the minority shareholder in your company, because this is your startup.
Let’s take an example, suppose there are a total of 100 shares in your company and 5 shareholders with 20% each. It means each of them has 20% ownership of the company. Suppose you want to raise money and offer 100 extra shares, and a single investor comes and buys all the shares.
Now understand the new shareholding pattern, the total outstanding share becomes 200. Since the new investor has 100 shares, so he becomes a 50% owner of the company while the other 5 shareholders become 10% each. As you can see, the ownership of the existing shareholders reduces from 20% to 10% because of share dilution.
You need to prove your business potential
To win the trust of the investor and convince them to invest in your business, you need to prove the potential of your business. For example, how your business is different from other businesses in the industry, what is your USP, what is your future plan, and a lot more.
Investors only invest in the businesses where they see growth in their investments. Now it’s your duty to convince the investor that you and your business have the capabilities to generate multi-bagger returns on their investment.
Decision conflicts
When there are more decision-makers in the company, there are chances of conflicts in the decision. Everyone has their point of view, some might agree with your point and some might not agree, hence more decision-makers turn out to be conflicted in their decision-making.
Lengthy and Complex process
The process of equity funding is complex and lengthy because a lot of paperwork goes hand in hand. Before pitching the investor you need to take care of the financial reports of your business that indicates your business performance.
You need to take care of the different compliance before and after funding. It’s better to hire a professional who takes care of all the paperwork and focuses on pitching the investor efficiently so that they become ready to invest in your startup.
Business Loan vs Funding: Which One Is Better for You?
Both options have their advantages and disadvantages as we have mentioned above. Which one is better for you depends on which type of convenience you want, like, if you don’t want any burden of a loan repayment then go for funding but if you don’t want to dilute your equity shares then go for a business loan.
Figure out which type of advantage you want and select the option based on that. Every coin has two sides, if there is a benefit in something then might be they have a certain downside.
Conclusion
The US government always tries to promote businesses with different schemes. Business loans and funding, both are great options. Because you are a startup and creating a foundation to build your empire, so you must choose the option very carefully. If you take care of all the above-mentioned facts into perspective, then most probably you will make a better decision.
FAQ
Is it a good idea to get a loan to start a business?
Loans help your business grow and a business loan will cover the upfront costs of expansion and allow you to make profitable growth.
How much can I get for a startup business loan?
Startup loans typically range from $9,000 to $20,000. Startup loan decisions are made differently from other forms of business financing.
What do I need for a startup business loan?
If you’re starting a business, you need money. So having a strong personal credit score and stable income will help you qualify for financing. A good credit score starts at around 690 to get a loan.
