Investing vs. Loaning Money to Your Business
Whatever business you’re up to, whether it’s a small retail shop or a full-blown manufacturing business, you will need money (probably more than you initially thought). Where do you get the money? Your first resort is going to be your personal savings. However, you still need "infusion of capital" to get started especially if you are joining a partnership.
Speaking of capital, business owners have two major options to get the funds they need. They could either invest or loan money. Both have advantages and disadvantages. In this article, it’s time to learn about them. Knowing the difference between investing bringing in an equity investor and taking out a loan is important in choosing the approach that’s best for you.
Borrowing Money to Fund a Business
Borrowing money to ‘make money’ is not a new concept. And not only it is a known fact, for many enterprises, it is also a shrewd choice.
Advantages of Business Loans
- You maintain full ownership of your business and the bank (or your lender) doesn’t get any portion of your profits.
- Managing repayments is less complicated than accounting for profits of your equity investors.
- You are free to use the money in any way that you see fit for your business.
- Interest can be deduced to business expense.
- If only a small amount of money is needed, it’s easier to get approved. There are also many types of loans available to suit your needs, from traditional bank loans to short-term loans. Business owners can even rely on personal loans online.
Disadvantages of Business Loans
- Having a poor credit rating lowers your chances of getting a loan.
- Sometimes, you need a collateral on personal property to have your loan approved.
- If the business fails, you are still obligated to pay it off.
Investing on Your Business
A common option for putting money on your business is to invest money. The funds go to your equity account. The term "equity" means value or worth which is generally referred to as the owner's ownership, defined as the amount of business assets you own. Another way to view it is that equity account is the amount the owner invested on the business, minus the money he has taken out. When you make an equity investment, it’s as if you are buying ownership as a ‘piece of a pie’. In most cases, the amount of money you receive is proportional to the money you invest.
Advantages of Equity Investments
- They may be able to provide large sums of capitals, whereas banks might have many hesitations to lend out money to business owners because of the risk of default.
- The repayment system is more flexible with equity investments than business loans.
- Because they are shelling out their own money, investors can help a business owner create ideas and strategies, through mentorship, to further boost the business.
- Investors are people who are interested in seeing your business succeed and grow because it will also mean ‘success’ for them.
- If the business fails, the owner in most instances, don’t have to pay back the investors as long as there is absence of fraud or similar.
Disadvantages of Equity Investments
- The business owner may have to share a larger portion of his profits with the investors.
- It can be difficult to find investors. Venture capitalists often invest on big businesses that they think can offer huge returns to their money, instead of small businesses.
- Investors gain legal rights when it comes to managing the business (and may become part of the board of directors). Thus, the business owner may no longer have full control over the day-to-day operations of the company.
If you’re starting a small business, what you should be looking are "angel" investors. Unlike venture capitalists who are focused on maximizing the returns of their investments, angel investors have more ‘altruistic goals’. Often, they are wealthy entrepreneurs who want to share knowledge and help small businesses succeed.
How to Avoid Tax Issues with Your Contribution
Whichever option you choose – loan money or invest – you should know how to deal with it in terms of taxes. If you’re borrowing money, make sure there’s paperwork involved. The written contract should cover the repayment obligation, penalties for non-repayment, and other terms and conditions. If you want to invest in your business, be sure to create a written contract as well and keep shareholder documents as a proof, including the number of shares you are purchasing.
What’s the best way to put money on your business? The answer largely depends on your tax and financial circumstances. There are some other factors to consider, such as your credit score (if you’re considering a business loan), how much you can invest, the status of your cash flow, and your annual forecast. Experts recommend discussing your options with tax professionals and business consultants before deciding and putting everything on a written agreement