Fundraising investments or taking a loan is a question, I often see being asked on Facebook groups for entrepreneurs or aspiring entrepreneurs.

This article will break down all the pros and cons so that any entrepreneur deciding between the two, may make a more informed decision.

Fundraising (equity financing)

Pros:

• No repayment obligations: Investors provide capital in exchange for equity, so there are no monthly repayments or interest.
• Reduced cash flow Pressure: With no repayment schedule, companies can reinvest more cash back into growth.
• Access to expertise: Investors may bring valuable expertise, contacts, and guidance.

Cons:

• Ownership dilution: You’ll give up a portion of ownership and control to investors, possibly impacting decision-making.
• Expectations of high returns: Investors typically seek substantial returns, which could pressure the company into fast-tracking growth and sacrificing fundamentals.
• Complex and lengthy process: Fundraising often involves significant time and resources to find the right investors and close deals.
• Equity cost: The potential value of the equity given away may outweigh the cost of a loan in the long term, especially if the business becomes highly profitable.
• Less than 1% of startups ever receive VC funding.

Taking a loan (debt financing)

Pros:

• Maintained ownership: A loan allows you to raise funds without giving up ownership or control of the business.
• Fixed costs: Loans generally come with fixed payments, making cash flow planning easier.
• Faster process: Loans can be secured relatively quickly (hours to days) compared to equity financing(months).

Cons:

• Repayment obligation: Loans require regular repayments regardless of the business’s cash flow situation.
• Variable interest rates: especially for loans come with variable interest rates, which can lead to unpredictable expenses if rates increase. This can create budgeting challenges and increase overall costs, especially if market rates spike over the loan term (Most business loans in Singapore are fixed terms).
• Reduced profit margins: Interest payments reduce net income, which can directly impact profit margins.

Apart from the above pros and cons for each type of financing, there are also circumstance-specific considerations. This brings me to Stage and Sector.

Sector

While equity financing isn’t exclusively available to tech startups, tech companies and other high-growth sectors tend to attract equity investors because of their potential for rapid growth and high returns. Investors are drawn to tech startups due to their scalability and disruptive potential in markets, which can lead to substantial returns which is required to offset the risk of an investment failure.

At times, the question is posed by a traditional business. But if less than 1 percent of startups ever receive VC funding, your odds are likely even lower. So, factor that in, lest you spend too much time on something where your chances are only slightly better than winning the lottery. That said, I do have friends in traditional businesses who received investment. However, the investors are more like new co-founders or business owners, often playing an active role in steering the business, rather than behaving like an investor.

Stage

The stage of your business is another consideration.

If you are just starting up, loans may be harder to secure, except for secured loans or personal loans, as your business will not demonstrate to lenders that you have the ability to repay them.

If you are a tech startup, note that in recent years, VCs have been expecting much more traction. Successful fundraising is also taking longer according to Carta. Angels could be a better option, except if you are from Singapore. The major angel networks typically invest at the Series A or even Series B stage (but they call themselves angels? SG’s founders need to speak up so things can change!) Platforms like Angel Investment Network where you can list your pitch and get discovered by investors from all over the world could be helpful.

If you are a revenue-generating startup, both equity and debt financing will be suitable options for you. Even if you are VC-funded, not taking the time to understand and explore how debt financing works means one less tool in your financial toolbox.

Taking small loans even when you don’t need them, reflects an established credit history and you as a reliable borrower that will aid you in taking larger loans in the future. It also helps to build relationships with lenders. During Covid 19, many banks prioritized their existing clients first due to the large amount of inquiries received.

If you are not profitable, but can demonstrate a path to do so and/or high potential – VCs would be suitable. For loans, unless it is a secured or personal loan, depending on your region, you are likely to have to go for non-bank lenders and a higher interest rate may apply.

Disclaimer, I am the founder of Singapore’s 1st loan marketplace for Singapore borrowers looking for cheaper loans, but we are also fundraising.

#Entrepreneurship #StartupFunding #EquityVsDebt #BusinessLoans #FundraisingTips #Ifvex