As a startup, what is best for you, a loan or an equity investment?
Loans are credits that you can borrow over a fixed amount of time from the bank. Loans can be secured or unsecured. If you borrow a secured loan you will be borrowing against an asset like a property. On the other hand, an unsecured loan is supported only by the borrower’s creditworthiness rather than assets. Borrowing a loan means you will have to pay interest, and the interest rate might be fixed or variable; this will depend on the type of the loan you decide to borrow.
Lenders can be a financial institute, an individual or a bank. Most loans in Iraq are made by banks and it can be a logical option when trying to obtain money to grow your business. But what are the pros and cons of obtaining a loan?
Pros
-The benefit of obtaining a loan is that you are not required to give away any equity. Lenders will not have any influence over your startup and you will have the complete freedom in running it. Your profit will be impacted by the interest charged by the lender on the loan.
-One key consideration that can help you decide on whether to obtain a loan or not, is the size of your fixed assets base. If you operate in a business where you have a considerable amount of fixed assets such as manufacturing or transportation, you can use those fixed as collateral and get a better interest rate.
Cons
-Banks are often wary and strict when lending money to startups, therefore they need to be convinced that the business will be profitable in order to repay the loan in time. To qualify for a bank loan there are a series of protocols and procedures that must be followed, and this can be time consuming and may lead to frustration. Also, there is no guarantee that your business loan application will be approved, or you might not be granted all of the money you requested. We recommend that you conduct a very good research on the criteria to avoid rejection.
-Using collateral to secure a loan does put your assets at risk of seizure by the lender if your startup fails to make loan repayments in time. Many assume this will not be the case, but it will become a problem when your business is not able to meet its debt obligations.
Think carefully before deciding to borrow a bank loan and in case a bank loan is not suitable for your startup, you can seek outside investors like Angel Investors or Venture Capitalists (VCs). But this funding method has its own pros and cons as well.
Pros
-The benefit of obtaining an investment from Angel Investors or VCs is that they are willing to risk investing in the early stages of your startup with no collateral like personal assets or interest to be paid. If your startup goes under you will have no obligations to pay the funds back to the VCs or Angel Investors unlike borrowing loans from banks.
-Getting funded by VCs and Angel Investors means you have access to investors’ sector knowledge, expert mentoring and guidance, which can be of tremendous value for your company’s growth and your personal growth as well. Also the wealth of contacts and networks that they provide to successful entrepreneurs and business leaders might be able to help your business become more profitable.
Cons
-Deciding to go with an Angel Investors or VCs funding means that you have to give part equity in return, this means losing complete control over your business. The Angel Investor or the VC will have a say in how you run your business and will also receive a portion of the profit.
Each funding method comes with its benefits and its drawbacks. It is important for any person thinking about obtaining funding for their startup to quantify their personal resources, to understand their desire of control, their ability to service debt and finally to understand how to leverage negotiations.
Have you ever obtained a loan or sought an investment? What was your experience like?