External financing is a tricky process for many businesses. The reason for seeking financing is an important consideration when weighing the advantages and disadvantages. Financing can help in hard times and accelerate growth when demand is high and the business needs immediate capital to hire additional workers to expand operations.
Funding your business by financing with an external loan has the advantage of delivering capital without you losing ownership or control of your company. Maintaining autonomy is a major advantage for any business owner or group of owners. An external loan does, however, come with an interest rate, payment demands and increased liability. Many lenders require collateral, and if you default on your payments, your business stands to lose critical equipment to the lender.
Utilizing an external line of credit as a temporary cash flow solution is a major advantage for revenue-positive businesses. Business models with variable invoicing periods can use a line of credit against unpaid billables without losing any assets or taking major risks. The line of credit is a useful resource, but it is intended as a short-term injection into the infrastructure and growth plan for the business as a whole.
Financing from venture capital and investors often comes with resources. Having experienced and successful investors who want to deliver capital is a great sign for any business. The combination of new capital, experience and expected return on investment can drive growth quickly. The downside to external capital of this nature is the loss of control and ownership in the company. Accountability to investors while receiving input and critical feedback is the norm. Some investors add stipulations that give them some control over internal processes as well. While ownership is reduced, the potential for a greater return on fewer shares is something to consider.
Many businesses are started with capital from friends and family. Accepting loans with loose terms is great for flexibility, and everyone wins with a successful venture. The obvious downside here is the risk associated with failure. Losing precious dollars loaned by friends and family causes stress and strain on relationships.
Ultimately, a business must weigh the risk versus the reward when it comes to external financing. Take into account the source, obligations, accountability and potential pitfalls of any new financing plan and then weigh it against the potential outcome.
