Venture Capital Vs. Business Loans: A Beginner’s Guide to Financing Alternatives

Introduction

Venture Capital or Business Loans, which is smarter for business?

Anyone who has a growing business needs an infusion of cash; taking advantage of business capital sources can help shed some of the stress.

So what’s the best route to take?

There is more than one way to fund a company and fuel its growth. The two primary funding sources are Venture capital and business loans. But how do you decide which type is right for your business? Each method can carry its advantages and disadvantages.

So in this article, we’ll explore which is best for you at your stage in business and help you decide on the right funding source.

Venture Capital

Venture capital can be a prominent option for many businesses. In venture capital, investors take a piece of a company’s equity in exchange for funds. Investors offer funds generally for up to 10 years, with the understanding of getting a return when the company is sold or goes public.

Venture capital financing generally provides capital to companies in their early stage of development. However, if an established business is looking for a funding source, in that case, venture capital might not be the solution. Venture capitalists commonly look to fund startups having the potential for long-term growth.

Advantages

#1. Monthly Payments

Since venture capital funding is not a loan, you don’t technically have debt on you. The investors have invested in your business for equity in the company. Unlike loans, you are not expected to pay the money back as it is free of any form of interest.

It is a great advantage as this frees up working capital for your business – allowing you to reinvest by improving products, hiring a larger team, or further developing operations.

#2. Guidance And Support

Venture capitalists are a valuable source for gaining business expertise. Other than expertise, they provide crucial guidance and knowledge related to running a successful business.

As your company’s partner, they provide support in the form of valuable networks and quality hires for the growth of your business.

#3. Networking Opportunities

When you are focusing on your business there isn’t much time to network with people that can help your business grow.

Since venture capitalists end up having shares in the company, it’s often important for them to spend their time building their network to assist the companies they invest in. Having access to their network can help you develop new partnerships, build out your clients, and hire key employees.

Disadvantages

#1. Founder Stake Is Reduced

While raising funds for a business you will need to dilute some of your equity to issue shares to your investors. Sometimes companies have to raise additional funds from venture capitalists. This results in losing decision-making power and percentages of equity in their company.

Many startups sometimes end up giving nearly 50% ownership to venture capitalists. And when you become a minority stakeholder in your company you lose the freedom to exchange equity for capital later in your business.

#2. Formal Structure

After the venture capital funding, a board of directors and a formalized internal structure is set up to facilitate growth and transparency for the company.

However, this can reduce the amount of control that the founders have and allow venture capitalists to have their voices heard during important board decisions.

Since founders give up some percentage of their stake in the company, the threat of losing ownership can be seen; at the time of a clash in beliefs between owners and venture capitalists.

#3. Negotiation

It is found very rare that there are too many investors who are interested in investing in the startup. Venture capitalists tend to be choosy, often making a small number of deals per year.

Most startups won’t have much leverage besides rejecting the deal. These can be reduced by starting your search early to find a venture capital firm that understands your goals and funding needs.

Business Loan

A Business loan is a complementary alternative to venture capital and can be a suitable funding option for a well-established business. Like any other funding, it is completely dependent on your financial requirements and your business goals that what funding source is well suited to your company. Though compared to venture capital business loans are found to be more flexible and more likely choices for businesses.

Advantages

#1. More Options

Depending on how much you need, you can be eligible for funding your business with a traditional or alternative business loan. The amount you can borrow differs from lender to lender.

Whereas you can have more loan options to choose from where you aren’t limited to a single type of loan.  Among all Working capital loans and business lines of credit  are the two common sources of business funding.

#2. Convenient and Easy

With many business loan options to choose from it becomes more convenient and easy for business owners. The more flexibility on how to use and choose your loan for business makes it easy to fund any business-related expense with no limitations.

Whether you need to order products, pay vendors, get ahead on payroll, increase your marketing budget–it’s all the same to the lender.

#3. Profit Is All Yours

When getting funds from an investor you have to dilute stake and share profit on any money you make. With business loans that’s not the case.

With a business loan, the  lender expects interest as repayment, resulting in retaining your business equity. When running an established business it becomes important to keep up with the majority stake of your business.

Disadvantages

#1. Not All Businesses Qualifies

When it comes to approving business loan applications, a lot of rules and considerations banks have in place. Many large and traditional banks require a good credit score before lending the funds. And not all businesses can meet the criteria.

#2. Not  Getting Required Funds

When applying for business loans it becomes crucial to get the required funds for the business. But it is very common for banks to not approve a loan as per the ask. Banks grant the money with the condition that only 70% or 80% of the money is given.

#3. Business Records

Many banks ask for an established track record which could include several years of successful operation before passing the loan. And it becomes difficult for startups or new businesses to bring the business record.

On A Final Note

Funding is important for any business for its growth. Hopefully, it is clear from the blog about the two primary funding sources, Venture Capital and Business Loans, to help you decide on the right funding source for you.

My Valuation is a full-service business valuation and advisory firm based in Bangalore and Ahmedabad.

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