Advantages & Disadvantages of Business Loans

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 What Are Business Loans? What Are the Advantages and Disadvantages of Business Loans?

Business loans refer to a specific type of loan that a business owner may seek out in order to assist in providing business startup and operating expenses. Generally speaking, business owners and entrepreneurs typically cannot afford to completely fund their business from the beginning, at least not on their own. This is especially true of small businesses.

Some examples of how business loans are commonly utilized in order to address business needs include, but are not limited to:

  • Down payments on business and/or office spaces;
  • Business equipment and supplies;
  • Funding for initial advertising campaigns and other marketing expenditures;
  • Paying off any debts that have accumulated over time;
  • Repairing business property;
  • Certain transportation and traveling expenses; and
  • Long-term business expansion goals.

Small business loans specifically are generally considered to be investments in the company’s growth. Largely, the goal is to ensure that the loan assists in stimulating profit, as opposed to creating additional debt.

It is important to note that business loans are considerably different from receiving financing through investors. When a business is financed through investors, which is also referred to as financing through equity investments, the business owner is making no guarantee that they will fully repay the investors. Rather, the investors purchase a piece of the business and as such, they take a risk on the business in order to be successful.

The largest advantage to obtaining financing through business loans rather than investors is that the business owner is able to maintain complete control and ownership of their business. Alternatively, financing through equity investments is beneficial in that the business owner does not need to pay back the loan, as the investors are paid through profit sharing and dividends.

There are considerable disadvantages for both business loans and financing through equity investments. When a business owner obtains a business loan, they are legally required to repay that loan in full, in addition to any interest that may accumulate. An example of this would be if a business owner takes out a loan of $750,000 for startup costs and operating costs. The owner would only keep the leftover profits once they have made their loan payment.

Alternatively, if the business is financed through equity investments, the business owner must share a portion of their profits the amount of time that the investor holds a share of their company. And, the business owner will be required to consult with that shareholder and edit their policies and practices to the shareholder’s expectations. As such, business loans allow the business owner freedom to operate their business how they wish, as well as the ability to retain any profits that are left after any loan payment.

How Will Financing Through Equity Investments Affect My Business?

As was just discussed, if you as a business owner choose to finance your business through equity investments, you are essentially selling a portion of your company to the investor. Generally speaking, investors hold a passive role in their investment. This is due to the fact that they generally do not wish to take on active roles, such as in the daily management and operation of a business. An investor such as this is simply seeking to invest in the company while hoping for a good return on their investment as the company grows and becomes successful. This is one of the advantages of equity financing.

However, financing through equity investments dramatically alters the structure of the business. You as the business owner are held accountable by the shareholders of the company. Should you lose your majority interest in your own company by not maintaining more than 50% stake, you will most likely lose a great amount of autonomy as well as management rights.

Another example of how financing through equity investments will affect your business involves liability. Shareholders and investors will generally also seek to limit their liability. What this means is that although investors are willing to voluntarily risk the money they invested, they are not willing to lose more than their initial investment through future business debts and lawsuits.

The three most common business structures which protect investors from being liable for company debts and lawsuits are:

  • Corporations: Creating a corporation also creates a legal entity which is distinct from the corporation’s owners. Generally speaking, corporation shareholders are free from any liabilities of the business, such as business debts or lawsuits. However, organizing a corporation is expensive, and corporations must adhere to strict guidelines regarding its organization and operation;
  • Limited Partnerships (“LPs”): Limited partnerships consist of one or more limited partners, and one or more general partners. Under a limited partnership, the general partner is responsible for the day to day operations, while the limited partner simply acts as an investor. However, the general partner remains liable for all of the partnership’s debts and lawsuits. The limited partner may also be held liable if they manage the business, or otherwise act as a general partner; and
  • Limited Liability Companies (“LLCs”): Similar to a corporation, an LLC offers limited liability to its shareholders. LLCs are considerably less strict in regards to their daily management. However, with less structure in terms of how the company is operated as well as less protection for investors, investors are slower to invest in an LLC.

What Are Assurances? What Assurances Must I Give a Lender?

Simply put, assurances are promises. Prior to lending money to a business owner, the lender will generally require multiple assurances provided by the business owner (or the party applying for the loan). An example of this would be if the applicant’s credit history or current assets are questionable. The business owner may be required to have a cosigner or guarantor sign the business loan as well, as that person would become personally liable for the loan repayments should the business fail.

Some other common examples of assurance that a lender may seek include, but are not limited to:

  • Collateral, such a vehicle title;
  • Additional information on the business, such as a business plan document or business financial statements;
  • Additional insurance information; and/or
  • Loan covenants, which are essentially conditions that the borrower either must fulfill or refrain from doing.

When you are considering applying for a loan for your business, you should consider what assurances are being asked of you and how well you will be able to make those assurances. Some other things to consider include:

  • Current loan rates;
  • How you plan to repay the loan in the long term;
  • Whether you have a sound budget in place for how the loan is to be spent; and
  • Your state’s laws regarding small business loans, and how those laws may benefit or affect local loan rates and lending practices.

Should I Hire an Attorney for Help with Business Loan Issues?

If you are a business owner and are considering financing through a business loan, you may wish to consult with an experienced corporate lawyer in your area. As previously mentioned, state laws can vary, and someone local will be best suited to helping you understand how those laws may affect you and/or your business.

An experienced local corporate attorney can help you obtain the correct loan for your business. Finally, an attorney can also represent you in court, should any legal issues arise associated with the loan.

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