Investor vs Loan: Which Makes Sense for Your Business

At some point, virtually any business will need additional funding to continue to grow. When that time comes, owners will want to compare the options available to make the best decision for their business.

Should you borrow money from a lender or seek out an investor? What are the advantages of a business loan as compared to money from an investor? Continue reading to find out which financing options make the most sense for your business.

[August 17, 2022 Update: The recent economic downturn may have impacted the cost of capital in 2022. As interest rates soar and investors are looking to secure their investments with higher returns on capital, debt financing is on the rise and may offer a more accessible alternative for brands to secure much needed capital.]

What is a Business Loan?

You’ve come up with a solid business plan and you’re seeing an increased interest in what you have to offer. But before you can ramp up your business, you need to find a funding option that allows for some healthy growth as you scale. One of those options is a business loan.

A business loan is money that you borrow from a lender that needs to be paid back with interest on a set schedule. This type of loan can be used in almost any stage of your business and can help fuel your growth.

Business Loans: Pros & Cons

There are a few advantages as well as disadvantages to procuring business loans that brands should be aware of:

Pros

No Equity Dilution - loan debt does not require you to give up a percentage of ownership and lenders can’t claim any of the profits of your business.

Flexible Terms - business loans often have flexible terms that can be worked out with your lender to match your unique needs.

Transparency - with a business loan, you’ll always know what you have to pay the lender back. Since these payments do not fluctuate, it is easy to plan ahead and forecast expenses.

Cons

Repayments - when businesses take on a loan, they agree to repay the money including interest. Payments need to be made regardless of financial position or seasonality.

Restrictions - agreements made with the lender can restrict some business activities or your ability to partner with other lenders during the partnership.

Collateral - to secure the loan, some of your assets need to be pledged as collateral. If you default on a loan, you might risk losing your assets that the lender will seize and liquidate to recover their investment.

What are Investors?

An investor is someone who is looking to put money into startup businesses that show a lot of promise, often based on innovation or a break-through idea.

Whereas lenders want to see that you’ll be able to repay the loan, investors know that their investment is tied to risk and provide money when there is significant promise of return.

Investors: Pros & Cons

There are both pros and cons to taking money from investors, some of which include:

Pros

No Repayments -there are no recurring payments that need to be made, and if your business fails, the money you received also does not need to be repaid.

Guidance - investors are often experienced and have industry connections that you can leverage to get ahead in business.

Credit Scores Not Important - investors are looking for break-through ideas and innovation, and credit scores bear little to no weight in the decision making process.

Cons

Equity Dilution - businesses give up a percentage of ownership in exchange for the money they get. This means that the investor will own part of your business, and most likely will want to have a voice when it comes to making management decision.

Possibly more costly - this depends on the specifics of your business, but equity can be more expensive than debt financing. Read more about equity vs. debt financing here.

Long-term relationship - when you finish repaying a business loan, the relationship with the lender ends. Investment capital, however, ties you to the investor for longer. By giving up a portion of equity, your business enters into a more permanent relationship with an investor with decision-making authority.

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Final Thoughts

After reviewing through the points above, you should have a better understanding of the pros and cons of both options. Partnering with an investor involves giving up partial ownership which gives them a voice in your business. Loans are a more short-lived partnership that ends when you repay the borrowed money.

There are many different types of loans based on your specific short or long-term needs, and there are many possibilities that come with small business loans, that you can read more about here.

Debt can help you stay in control of your business and may be less costly in the long run than giving up equity. It is a great way to fuel your growth and put your business on the right track to profitability.

The best choice may come down to a few factors unique to your particular situation. After reviewing your books and choosing the lenders that stand out to you, it is worth discussing your options to get a better understanding of what is being offered and what makes the most sense for your business.