Should You Borrow or Seek Investment?

What is Better - Incurring Debt or Losing Ownership?

Your first consideration for funding is whether you want to seek a loan or an investment. The advantage of a loan (debt) is that you are not giving up any ownership in your enterprise, and the lender has no management say or direct entitlement to profits in your business. Your only obligation to the lender is to repay the loan on time and you can deduct the interest payments at tax time. The disadvantage of a loan is the debt—the looming monthly payments and the potential for personal liability (if you guaranteed the loan), loss of property (if you secured the loan), or a lawsuit if you default on the loan payments.

The advantage of an investment (equity) is that you will not have to repay investors if your business goes under, and your personal property is unlikely to be at risk. The disadvantage is that you get a smaller piece of the pie because you are giving up a share of the business. And if an investor seeks to control your business, it may be more of a nuisance than a help.

Look to Family and Friends

Sometimes, your funding choices are made for you. For example, if you don't qualify or have enough resources to get a loan, then you need to find investors. The most common sequence for finding investment? (1) Look to your own resources, (2) look to family, and (3) look to friends. After exhausting those, look to an interested outsider.

Most likely, obtaining an investment will require some additional expenses incurred by your accountant and your lawyer. For example, if the investment is substantial, the investor may require that you convert your sole proprietorship to a corporation to shield the investor from personal liability.

Why Do You Need the Money?

In general—whether you seek investors or lenders—you need to determine whether the money is needed for a temporary problem or a fundamental problem. Often, temporary problems can be resolved with a simple funding solution such as a merchant card account. But a fundamental problem—for example, lack of sales, too high cost of sales, too high administrative costs, too much inventory, too much accounts receivable—usually will not be cured by borrowing money. In that case you need to address the fundamental problem and it's not a wise idea to borrow until you have done that.

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