Key Takeaways
- Business loans, equity financing, and bootstrapping are three ways for businesses to gain the financing they need.
- Equity financing provides capital without the need for repayment but involves sharing ownership and profits with investors.
- Bootstrapping allows complete control and ownership but may limit growth due to relying on personal or internal resources.
- Choosing the right financing strategy depends on your business's financial position, growth stage, and long-term goals.
One of the first steps to starting or expanding a business is to secure funding. Business owners usually have several strategies to choose from. Three choices business owners have are business loans, equity financing, and bootstrapping. Each approach has unique pros and cons that you must consider. The best choice rests on various factors such as the business’s financial position, growth stage, and long-term goals.
Let’s explore this comprehensive business loans comparison, examining how loans stack up against equity financing and bootstrapping, and help you make an informed decision for your business.
Understanding Business Loans
Small business loans are a traditional method of financing where a business borrows a sum of money from a lender, such as a bank or financial institution, and agrees to repay it with interest over a specified period. Business loans come in several forms, including term loans, lines of credit, and equipment financing, each tailored to meet the different needs of a business.
Advantages of Business Loans:
- Retain Ownership: One of the most significant advantages of opting for a business loan is that the owner retains full control over the company. Unlike equity financing, where ownership stakes are diluted, loans do not affect the ownership structure.
- Predictable Repayment Structure: Business loans typically come with a fixed repayment schedule, allowing businesses to plan their finances more predictably.
- Maintains Operational Focus: With a business loan, business owners can continue to focus on day-to-day operations and growth strategies without the need to manage investor relations or stress about generating enough revenue to fund needs.
Disadvantages of Business Loans:
- Debt Obligation: Taking on a loan means committing to regular repayments, which can be a strain on cash flow, especially if the business is not yet profitable or is facing a downturn.
- Changing Interest Rates: Business loan interest rates are always subject to change depending on the Reserve Bank of Australia’s cash rates and other factors. Even with a fixed-rate loan, the fixed period is limited to 1-5 years, which means the rates for the rest of the life of the loan can change at any time.
- Potential Loss of Assets: In the event of a default, the lender will try to work with the business to resolve the debt. However, as a last resort, the lender can take ownership of business assets and sell them to recoup losses.
Equity Financing: Selling a Stake in Your Business
Equity financing involves raising capital by selling shares of the company to investors. This could be done through angel investors, venture capitalists, or even crowdfunding platforms. In exchange for their investment, investors receive a share of the business and potentially a say in how it is run.
Advantages of Equity Financing:
- No Debt Repayment: Unlike loans, equity financing does not require repayment. This can be particularly advantageous for startups that may not have steady cash flow initially.
- Access to Expertise and Networks: Investors often bring valuable experience, industry connections, and strategic guidance, which can be crucial for business growth.
- Improved Financial Health: Equity financing does not add debt to the balance sheet, potentially making the business more attractive to future lenders or investors.
Disadvantages of Equity Financing:
- Loss of Control: By selling shares, business owners give up a portion of their ownership and decision-making power. This could lead to conflicts or differing visions for the company’s future.
- Dilution of Profits: Future profits will need to be shared with new investors, potentially reducing the returns for original owners.
- Complex and Time-Consuming Process: Raising equity often involves a lengthy process of pitching to investors, conducting due diligence, and negotiating terms, which can be both time-consuming and costly.
Bootstrapping: Using Personal or Internal Resources
Bootstrapping is when a business only uses existing resources instead of relying on investors and lenders. This involves funding using personal savings, revenue generated by the business, or by carefully managing expenses to avoid taking on external funding. This strategy is often used by entrepreneurs who want to retain full control over their business.
Advantages of Bootstrapping:
- Complete Control: Bootstrapping allows business owners to maintain complete control over their company without interference from investors or lenders.
- Low Financial Risk: By avoiding debt and external investors, the financial risk is limited to the owner’s personal investment and resources.
- Encourages Efficient Operations: Bootstrapped businesses tend to focus on lean operations and cost management, which can lead to healthier financial practices in the long run.
Disadvantages of Bootstrapping:
- Limited Resources: Without external funding, growth may be slower due to limited resources for expansion, marketing, or hiring.
- Personal Financial Risk: Using personal savings or assets to fund a business can be risky, particularly if the business does not succeed.
- Growth Constraints: Relying solely on internal funding can limit the ability to seize new opportunities or scale quickly.
Business Loans Comparison: Loans vs. Equity Financing vs. Bootstrapping
When comparing business loans with equity financing and bootstrapping, it’s essential to consider the specific needs and circumstances of your business. Here’s a closer look at how each option compares:
Cost of Capital:
- Business Loans: The cost is primarily the interest rate charged by the lender. Rates are often predictable and can be managed through careful financial planning. You can check our business loan calculator to see how much a loan would cost you over time.
- Equity Financing: The cost is less tangible but can be higher in the long term, as it involves sharing future profits and potentially ceding some control.
- Bootstrapping: The cost is generally lower upfront but could involve substantial personal financial risk, slower growth and loss of returns because of a lack of capital.
Control and Ownership:
- Business Loans: Loans don’t affect the ownership of the business.
- Equity Financing: Involves sharing ownership and potentially giving up some control over business decisions.
- Bootstrapping: Full control is maintained but at the potential expense of personal financial risk.
Risk and Liability:
- Business Loans: Involves financial risk related to loan repayments, personal guarantees and security.
- Equity Financing: Low financial risk for the business in terms of debt but high in terms of ownership dilution.
- Bootstrapping: High personal financial risk, especially if using personal savings or assets.
Scalability and Growth Potential:
- Business Loans: Provide capital for growth but have potential to limit future cash flow due to repayment obligations.
- Equity Financing: Offers significant capital for scaling without immediate repayment, ideal for high-growth startups.
- Bootstrapping: Limits growth potential to what the business can generate internally, which might be slow at first.
What to Consider Before Choosing a Financing Option
Here are some important factors to consider while making your business loans comparison against equity financing and bootstrapping.
Business Loans
- Creditworthiness: Assess your business’s credit history and score, as most lenders require a good credit standing to approve a loan. A higher credit score often results in better interest rates and loan terms.
- Repayment Capacity: Evaluate your cash flow to ensure you can meet the monthly repayment obligations without straining your financial resources. Consider the impact of loan repayments on your operational budget.
Equity Financing
- Willingness to Share Ownership: Reflect on your comfort level with giving up a portion of your business’s ownership and decision-making power to external investors. Understand the potential for differing visions or conflicts.
- Long-Term Impact on Profits: Consider the impact of sharing future profits with investors, which could reduce the amount of earnings that remain with the original owners.
Bootstrapping
- Personal Financial Risk: Consider your ability and willingness to use personal savings or assets to fund your business. Understand that bootstrapping involves a high level of personal financial risk, especially if the business faces difficulties.
- Growth Rate Expectations: Evaluate whether the slower growth often associated with bootstrapping aligns with your business goals. Bootstrapping may limit your ability to scale quickly due to limited access to external capital.
Making the Right Choice for Your Business
Choosing the best financing strategy depends on your business’s unique circumstances, including its current financial health, growth stage, market conditions, and long-term vision.
Consider Business Loans
…if you want to maintain control over your business and have a predictable repayment plan. This is a good option if you can manage repayments. Check our business loans guide to know if this is the right solution for you.
Opt for Equity Financing
…if you are looking to scale rapidly and need substantial capital without the pressure of debt repayments. This option suits businesses willing to share ownership and benefit from the expertise and networks of investors.
Go with Bootstrapping
…if you prefer to retain full control and have the financial means to fund your business without external help. This is often the choice for businesses that prioritise steady, controlled growth and lean operations.
To Sum it Up
Business loans, equity financing, and bootstrapping are all viable options for business owners to gain the funding they need. Each option comes with its own set of advantages and disadvantages. The key is to thoroughly evaluate your business’s current situation, future prospects, and risk tolerance before making a decision.
Get a Business Loan With Us
At Dark Horse Financial, we’re experts in commercial finance. With more than a decade in the business, we know the ins and outs of lending in Australia and the right lenders that can match your needs.
