Business Loan vs Equity Financing - Which one is Right for your Business?

Once you begin a business, you need to constantly sustain it and earn profits for the same. You can easily begin a bootstrap company; it means investing personal capital. Although growing a business with just an initial capital investment is not possible. Just as you need to oil a machine to work, you need to invest more capital for a business to run.

Just as profit is the primary motive of almost all business organizations, capital is the priority requirement of the same. If you wish to expand your business and take it to the next level, you will need the right kind of financing to support your ideas and plans. In today’s start-up culture, many such modes are being introduced. The 2 most common ways that businesses raise capital are through either business loans or leveraging equity financing options. Let us understand them.

What is a Business Loan?

A business loan is considered to be a debt financing mode of raising capital. In this mode, you take up loans from financial institutions such as banks or non-banking financial companies (NBFC), etc. Here there are 2 parties – borrower and lender. Depending on the amount you need, your eligibility and the lender’s policy, business loans can be secured or unsecured. Secured loans are obtained when you pledge assets such as immovable property (loan against property) or financial assets (fixed deposits - overdraft facility, market linked instruments - loan against securities) as collateral.

Unsecured business loans are obtained based on factors such as the borrower’s creditworthiness, business profitability, stability of income, etc. - usually upto a maximum of INR 75 Lakhs*. It is the most simple and popular way of raising money. The positive angle of borrowing a business loan is that you need not give up control over your business to the lender or part ways with your equity. You will continue to be the sole owner & decision maker of the business.

What is Equity Financing?

The other popular mode of raising capital is equity financing. Here, you can raise capital but in exchange for the same, you need to provide ownership rights to the lenders. Equity financing can be done through Venture Capitalists (VCs), angel investors, Private Equity (PE), and other modes. A company in the growth stage can raise money through this mode. The financiers or investors have a say in the business matters and need to be aware of what is going on in the company. As the business grows, so does its value, and thereby the return on equity for its investors. In case the business fails, the investors have the right to sell off the business and/or its assets in order to recover their losses. Depending on the quantum of equity funded, the investors also have the right to take part in decision making in terms of business operations and management.

Must Read: Here You Can Know About Business Finance

As we have an overview of the 2 main modes of financing for a business, let us understand which is better and which one will suit your business.

Equity Finance V/S Business Loan

• Timeframe
  A business needs capital to expand its operations and reach. The capital requirement is immediate and thus the process of acquiring the same needs to be quicker. Taking up a business loan is quicker, as with growing technology your business can also apply for an online business loan. While raising capital through equity financing takes time, sometimes even upto a year or more after finding interested investors. Depending upon your urgency you can make a choice. 
• Security of Assets 
  In business loans or debt financing, assets may or may not need to be pledged as collateral. In equity financing, there is no requirement of providing assets or any collateral. If you are a small business and do not have many assets, but are able to find interested investors, you may choose equity financing. 
• Liability 
  If you take up a business loan, you are liable to repay the money with interest. If you fail to repay any EMI (Equated Monthly Installments), the company will be prone to a costly financial mistake. In case of default, any assets pledged will be repossessed by the lender and the borrower’s credit score / ratings are badly impacted. On the other hand, in equity financing, while the borrower is not under obligation to repay the amount, their only focus is on taking smart business decisions so as to grow the company’s value as per the plan agreed upon with the shareholders. Failure of the company to perform in case of poor business decisions made by the senior management could be costly, as the shareholders have the right to sell off the company’s assets or change the management.  
• Ownership Control 
  In debt financing, the business does not have any strings attached to the lender. The lender only has the company’s assets as collateral but does not have any say in the business. While in equity financing, the lenders are given equal rights to know about the company, its operations, and its profitability and have an equal say in the same. It is like you are raising money in exchange for ownership rights from the lender. 
• Business Expertise
  As the lender does not have any say in debt financing, the company does not have any value-add or expertise on the table, just capital is added. In the case of equity financing, if you get an investor who has industry knowledge, you can use their capital as well as experience, network and knowledge to grow your business by making smart decisions.

Conclusion

Both the options have their pros and cons, thus making an informed decision is crucial. After overlooking the above factors, you may choose which option is most suitable for your business and works in your best interest.

SMFG India Credit provides eligible borrowers unsecured business loans upto INR 75 Lakhs* at attractive interest rates and tenures upto 48 months*. You can also check our secured lending products such as loan against property and loan against securities. Apply today or visit your nearest branch to know more.