Loans and Equity Investments Compared

How to choose between getting a loan or selling part of your business to an equity investor.

To raise money for your new business, you must decide whether you would prefer to borrow money or sell part of your venture to an equity investor. This assumes, of course, that both options are open to you. In fact, you might not find a lender willing to lend you money or you might have a hard time convincing an investor to put money into your business. But you should nevertheless understand the trade-offs that come with choosing one over the other.

Here's a comparison of the pros and cons of each method of raising money.

Loans

Loans are often better for businesses whose cash flow allows for realistic repayment schedules and can't require a pledge of anyone's personal assets.

Advantages
  • The lender has no profit participation or management say in your business.
  • Your only obligation is to repay the loan on time.
  • Interest payments (not principal payments) are a deductible business expense.
  • Loans from close relatives can have flexible repayments terms.
Disadvantages
  • You may have to make loan repayments when your need for cash is greatest, such as during your business's start-up or expansion.
  • You may have to assign a security interest in your property to obtain a loan, which may place personal assets at risk.
  • Under most circumstances, you can be sued personally for any unpaid balance of the loan, even if it's unsecured.
Equity Investments

Equity investments are often the best way to finance start-up ventures because of the flexible repayment schedules.

Advantages
  • You can be flexible about repayment requirements.
  • Investors are sometimes partners or board members and often offer valuable advice and assistance.
  • If your business loses money or goes broke, you probably won't have to repay your investors.
Disadvantages
  • Equity investors require a larger share of the profits.
  • Your shareholders or partners have a legal right to be informed about all significant business events and a right to ethical management. They can sue you if they feel their rights are being compromised.

If you don't already know an accountant specializing in small business affairs, you may want to find one to help you make the decision. Your personal tax situation, the tax situation of the people who may invest, and the tax status of the type of business you plan to open are all likely to influence your choice.

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