Raising Money For Your Small Business: Loans Vs. Equity Investments |
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In the first option, you can borrow money from friends or relatives. You may also be lucky to be able to get small business loans from a commercial lender. The main advantage of taking small business loans is that the lender will not interfere in the way that you run your business, although you will have to pay interest to the lender for using his money. Moreover, the lender cannot stake any claim on the profits that you make. All that he can demand is that you should repay your small business loans on time. The interest payments (not the principal repayments) are deductible as business expenses. There are two ways of raising money for your new business. You can either borrow money or sell ownership rights to equity investors. There are advantages and disadvantages of both these options and you should weigh them carefully before taking any decision. Borrowing money from friends or relatives would be advantageous in the sense that the interest rate would be lower than what commercial lenders charge. You can also avoid paying the loan fees that commercial lenders tend to charge. You might also be able to negotiate more flexible repayment terms of your small business loans in relation to what a commercial lender would agree to. The disadvantage is that depending on the needs of the friend or relative from whom you have got the loan, you may have to repay the loan when your own need for cash is at its peak (usually during your business's start-up or expansion). Moreover, if you face difficulties in repaying the small business loans or are unable to keep up with the payments, your relationship with the friend or relative will be at stake. On the other hand, taking small business loans from a commercial lender might require you to pledge property as security for the loan. You can also pledge your business property or personal assets such as your house or stock portfolio. In any case, if due to any reason your business takes a downturn and you are unable to make the loan payments, the lender can take your property and sell it to recover the money. You could lose your valuable business assets just when you need them the most. Moreover there is nothing worse than losing your house or stock profile. Even if you try to create a limited liability for yourself by organizing your business as a corporation or a limited liability company, commercial lenders would still require you, as the owner of a new or small business, to personally guarantee your small business loans and/or to pledge personal assets to cover the loan. This would negate your limited liability. You can also raise money from friends or relatives who want to invest in your business outright (become part-owners) instead of simply lending you money. These people (also called equity investors) would have a direct say in the management of the venture and would be entitled to the profits of the business. On the other hand if you take small business loans from lenders, the lender would not be entitled to the same. With commercial lenders, your only obligation is to repay your loans on time. If your business loses money or goes broke, you probably won't have to repay your investors. Making the right decision regarding the above options can indeed be very tricky. You should consult a tax advisor who can show you the right path after evaluating your personal tax situation, the tax situation of people who may invest, the terms of potential small business loans, and the tax status of the type of business you plan to open. For starting a new venture, you should seek equity investments, as you will only have to pay investors if the business makes a profit. Small business loans are better for ongoing needs of businesses with cash flow that allows for realistic repayment schedules, and for businesses that can obtain the small business loans without endangering personal assets. |
