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Business Debt

When money is needed, a business must make a decision. Should money be borrowed or ownership interests sold to equity investors? Business owners often find they have few options - however the lender or investor will have a voice in the decision. There are advantages and disadvantages associated with both choices. Business owners need to closely consider the ramifications of this seemingly simple decision.

The Business Loan

Borrowing money has many advantages. Many businesses turn to friends, family and commercial lenders.

The main advantage of taking out a business loan is that the lender gains no control of your management of the business. Instead, the lender receives interest payments on the amount borrowed. Lenders are not entitled to the company profits. All the business owner is responsible for is repaying the loan on time. Many interest payments are tax deductible as a business expense.

Many business owners are able to borrow money from friends and family. This option usually offers lower interest rates and the absence of loan fees. You can negotiate flexible repayment terms.

However, when you borrow money, you are committing your business to a large business expense. You will have to make loan payments. This can be difficult if you have a lack of funding, such as during the start-up and expansion phases. If you have problems repaying your debts, you can ruin your relationships with your lenders, family and friends.

Borrowing from a commercial lender often requires collateral for security on the loan. If you default on the loan, the lender will take the property and sell it. If you can't make your loan payments, you may lose the assets that make up your business. If you pledge personal assets, you could lose your home or financial future.

The Acceptance of Investors

Many business owners have friends, family and supporters who want to invest in the business instead of lending money. This is a successful way to raise money for a small business. However, these equity investors become part-owners in your business. There are advantages and disadvantages to this option.

Equity investor funding will allow you to use cash to pay for business startup expenses. If your business loses money or goes broke, it isn't likely you will have to repay your investors for their initial investment. You should thoroughly disclose all of the risks involved in your business. Make sure that your investors understand that they are not guaranteed to get their money back. You will often find that your investors have business experience and can offer assistance, advice and moral support.

However, equity investors often require a larger share of your profits than banks or lenders. This is due to the increased risk to the investor, compensated with a larger payoff.

Keep in mind that investors are co-owners in your business. They have a legal right to be informed. They are also entitled to ethical management within the company. If the investors feel that there rights are not afforded to them, they can sue you. When you take on investors, you must consider your responsibilities before you make business decisions.

Some investors are simply passive investors. When this is the case, their investment interests are called securities. Dealing with securities can be a headache in some ways. There is a lot of paperwork, from securities registrations to other legal requirements. There are some offerings of securities that do not require registration with the securities exchange commissions. They include:

" Offerings of limited size,
" Private offerings to a limited number of persons or institutions, and
" Intrastate offerings.

Making the Decision

If you are financing a startup business, it is often better to seek equity investments. With loans, you must repay the funding regardless of the performance of your business. Investments are generally only repaid through the profits of the company.

For ongoing business needs, loans are better for businesses that have adequate cash flow supplies to repay loans. Businesses should try to secure loans without putting any personal assets on the line.

Deciding between borrowing money and taking on co-owners is a big decision. Talk with a tax adviser who specializes in small business issued before making your final decision. The adviser can help you decide based on your personal tax situation, the tax situation of potential investors, the terms of the potential loan and the tax status of your start-up business.