Private Equity Investments Vs. Business Loans: What You Need to Know
So, your idea for a new business worked! Now, you’re at a stage where you need financing, fast, or else you may not be able to sustain growth.
What happens next?
Most business owners in this position go down one of two roads. Either they seek out a private equity investment to get capital and relinquish full control over the company, or take out a small business loan.
Should You Seek Out a Private Equity Investment or A Business Loan?
Both choices result in capital to grow your company, and push it to the next level you’ve been striving toward. But with what strings attached?
The choices you make early on in the life of your start-up can have lasting repercussions on your business. But more importantly, it can impact the way that you, personally, benefit from your business’s success.
Understanding the long-term impact behind both of these decisions can set you on the right path to financing for your start-up or young business.
To make matters more complicated, there are a few different types of private equity investments you can seek out.
What is an Angel Investor?
Angel investors have a reputation of coming in at the eleventh hour to save the day. Generally, angel investors are individuals with a high net worth looking to invest in a rapidly growing company.
However, most angel investors also have some business experience of their own. According to a Harvard Business School study, 55% of angel investors previously founded or served as CEO for their start-ups.
Angel investors are particularly popular in technology (51%) and financial services (39%) industries.
Unlike investors who provide capital at later stages, angel investors offer capital much earlier on, when companies believe they have no other funding options.
Why Do Start-Ups Choose Angel Investors for Funding?
Angel investors can be a beneficial resource for start-ups in a desperate position.
Angel Investors Don’t Look for Experience
Angel investors do not have financing qualifications the same way that banks and alternative lenders do. Because these are private individuals choosing how and where to invest their money, they can make choices based on their own criteria.
Generally, these investors make decisions based on the individual business owner, how innovative the idea is, or the entrepreneur’s skills.
The more promising the idea, the more likely the angel investor is to put stock (and capital) into it. After all, angel investors can only earn a high ROI when an idea takes off.
Lighting the Way As Your Company Grows
Angel investors rarely take a capital-only approach. In fact, most will take an active role in helping your company to grow, too.
When your start-up is growing rapidly and struggling to gain footing, this can be quite helpful. Thanks to business experience, angel investors have a unique perspective. By sharing this perspective, they can help your company to grow and reach higher profit margins.
Often, the role the investor plays in guiding the company can grow over time, occasionally taking the reins from the entrepreneur.
Potential for Future Funding Down the Road
Business partnerships are hard to forge early on, but can be crucial to sustaining your growth and accessing resources later on. Down the road, angel investors may be open to providing even more funding later on.
However, it’s important to remember that accepting even more capital from an investor entitles the investor to a larger percentage of your revenue.
No Repayment Required
One appealing part of partnering with an angel investor is that there is no repayment required, unlike a business loan. Once you accept the money, the capital becomes yours to use for any purpose selected by you or your investor.
You’ll never have to repay a dime of the capital, as the investor is instead paid through your company’s revenue on a continuous basis.
The Flip-Side: What Else You Need to Know About Angel Investors
Depending on the agreement and your relationship, angel investors may not be quite so angelic.
There are some negatives to keep in mind as you search for financing.
Forfeiting Sole (or Shared) Company Ownership
As of now, you (or you and your business partners) own your company. If you opt to seek out or accept help from an angel investor, then everything changes. You and your business partners would no longer have sole ownership of the company.
Instead, the company would be partly owned by the investor as well. The exact percentage varies based on the amount the investor contributes.
If investors (or a group of investors) own the majority of your company, then they could even vote to remove you from your own company.
Lose Access to Profits Forever
Bringing on an angel investor can shake up your bottom line as well. When you accept capital from the investor, you will also lose access to the profits.
The more capital the investor provides, the more of your revenue they’ll have in the future. Unless you buy the investor out down the line, they’ll be entitled to this profit forever.
Angel Investors are a Short-Term Solution, But a Long-Term Expense
The magic number can be enticing, and difficult to refuse when you’re in the early stage of your business. But as you journey into the future, accepting this capital could cost you a significant share of your revenue.
In the short-term, you’ll receive money right away. But in the long term, an angel investor will cost your start-up dearly.
Well, What About Venture Capitalists Then?
If angel investors are out, what about venture capitalists?
Unfortunately, funding from a venture capitalist can be even more difficult to obtain, and cost even more in the long run.
In the grand scheme of things, venture capitalists operate in much the same way as angel investors. They’ll invest capital, receive equity in return, and generate a percentage of these profits.
But there are a few key differences.
Venture Capitalists Invest in Older, More Profitable Companies
Angel investors readily invest in younger companies, but venture capitalists aren’t so eager to do so. In fact, their investment criteria is quite different.
Rather than targeting younger companies without any capital, venture capitalists are primarily interested in funding lucrative companies with massive potential.
For this reason, the investment is usually much larger, too.
Larger Funding Amount (And Equity Share)
Venture capitalists skilled in identifying lucrative opportunities. When they do, they’re more likely to make a sizable investment with a huge ROI potential than to dip their toes in the water.
Angel investors tend to invest, on average, around $25K in new opportunities. For younger companies, this capital injection can be a crucial push along the road to success. But for more established or ambitious start-ups, it might not make the cut.
On the other hand, venture capitalists will contribute a far more significant amount of money, generally in the neighborhood of $1-5 million.
With this larger investment comes a larger share of start-up equity, and a lower potential for the innovators in the start-up to profit.
More Corporate Structure
Angel investors tend to exist as individuals, investing in opportunities they deem profitable. There is nobody else holding them accountable for these decisions, except a possible financial advisor.
Venture capitalists generally exist as corporate entities. With access to funds from multiple individuals, VCs allocate these funds across several promising start-ups. The number can vary by quite a bit, and the diversity of the industries can vary as well.
Some venture capitalists specialize in a certain industry, like social media, tech, or finance. Others choose a different strategy by investing in multiple industries to diversify the risk associated with these investments.
Do The Math: Business Loans Win Every Time
When you take out a business loan, you’re agreeing to repay the capital you take out, plus interest. But in the grand scheme of things, this cost is significantly lower than taking on an angel investor.
To start, you can maintain both control over both your company’s direction and your revenue. Your lender is just a financial resource; you’ll never submit to any specific direction or requests!
For example: say you choose to borrow $200,000, to be repaid over the course of three years. Three years from now, you’ll have repaid the loan in full. Then, you can utilize your revenue stream to grow your business even more.
At no point will you have to worry about forfeiting revenue, or taking direction from anybody else about the growth of your own company.
When it comes down to it, interest is a small price to pay for unrestricted access to your revenue, and control over your company.
At National, we take the heavy lifting off of your hands by comparing loan amounts, rates and terms from over 75 lenders to give you the best deal possible. Get started today by filling out the 60-second application!
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