Loans or Investors?

Determine the Funding and Capitalization of Your Business

Your business plan should adequately address the funding requirements of your Company in order to get the Company off the ground and running. Funding can come from various sources but basically broken down as follows:

(a) loans

(b) investors

Here, we discuss generally some of the pros and cons of each type of funding strategy.

Loans

If funding is coming from lending sources such as a bank, or private lending sources, then commercial loan agreements will need to be drafted or reviewed.

Your business attorney will have to either draft or review most, if not all, of the following documents: loan security agreements, note, personal guarantees, global certification, opinion letters, pledge agreements etc.

Qualifying for a loan will depend on a list of factors such as, prior related experience, current assets, credit, who is guarantying the loan, prior financials, the depth of your business plan, and having the right business governance documents and business contracts in place (to show you have mitigated risks).

The clear advantage of a loan is you do not have investors who have a piece of the pie and to whom you as a business owner will owe a fiduciary duty. It’s a clear cut financial relationship.

However, that does not mean that your loan cannot come with restrictions on your business activities. Lenders rightfully may want to restrict your decisions if those decisions have a significant impact on their investment.

Investors

The types of investors can be broken down into multiple categories such as founder investment, seed investors, Series A, Series B, Series C, etc.

If your business funding will come from individual or corporate investors you will need to properly document the rights and obligations of those investors in a well drafted and probably extensive business governance documents (i.e. shareholders agreement, operating agreement, buy-sell agreement, etc.).

Of course your funding can also come from venture capital sources or angel investors which will largely be documented according to those investor’s preferences.

Funding can also come from private and public offerings which are governed by State and Federal regulations, are generally very expensive, and will require the planning and expertise of numerous legal and tax professionals.

The draw back of investors is that unless they opt to be passive they may require a say in the management of your company which may or may not be desirable depending on your goals.

Sometimes you have no choice but to take on investors. Say for example you are a very early stage startup with not much directly related experience, so-so credit, and insufficient assets to even be considered for a loan. You may initially turn to friends and family for seed money as your only option.

However, regardless of the type of investor or stage of investment, your investors will want to know (1) that you’ve considered all of your potential risks (2) that you have a plan for making money (3) that you have as many necessary business contracts in place that are properly drafted to protect the business and (4) that you have a viable business plan.

Conclusion

Choosing a loan vs. investor oriented approach will, like anything else, depend on your personal and long term business planning goals.

Like just about every other aspect of this post, having a business attorney, consultant, and CPA to discuss and analyze your options is a highly recommended first step.

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