Bank vs. Investor Funding: Which Option is Best for Your Business?
| 3 minutes read
If you’re starting a business or planning to start, you must have thought about how much money you need to get started. However, you may also realize that you don’t have sufficient financial backup to get started.
So, what do you think or do?
You think about Bank loans, Investors, Crowdfunding, etc., right? But how could you figure out that a loan or investor option is good for your business?
We guess you don’t think much about it. At that moment, you mainly focus on capital from any source.
To change this thinking, we will talk about which option is best for your business. So kindly stay with us till the last to get the final output from the article.
Generally, there are two investment options for investors. One is a loan, in which the lender makes money by charging the interest over a specific period of time. The other option is an investment. The investor option is an agreement in which the investor agreed-upon percentage of ownership (i.e., number of shares) in the business to provide the capital. In this instance, the investor hopes that the business will grow substantially over time so that their stakes in the company will appreciate value, thereby earning a Return on Investment.
When you write or plan your business plan, you want to keep your audience in mind. A loan and an investment are two separate things, and the ways that lenders (bank) versus investors earn money are different enough to require other business plans. To help your business and pursue the funding you need, here are the primary differences between a bank and an investor’s business plan.
Return on investment (ROI)
If you are looking for investor funding, prospective investor(s) will want to see an ROI scenario that shows the business’s current and estimated future valuation. A company determines its current valuation via the requested investment amount and the percentage of ownership in return for the investment. However, it is crucial to record that the valuation is primarily based on perception when seeking investment, especially for a start-up, and potential investors may disagree with your perceived valuation.
While there are certified and qualified business valuators, you can hire to determine a precise business valuation. The latter is generally accomplished by taking your EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) from a specific year in your income receipt and multiplying it by a multiplier to determine your future valuation in the same year. Although the EBITDA times multiplier is the most common method, some industries have different recommendations for calculating future valuations.
If you are seeking investor funding, prospective investors (s) will want to know all the scenarios/situations they can exit if required. One possibility consists of investors selling the company’s shares back to the company at good values at a future point in time. It is not limited to the business failing and the investor losing their investment or the company being successful to the point of having an IPO and having its shares publicly traded on a stock exchange.
If you are looking for a bank loan, then an exit strategy is not necessary unless you plan to exit the business before the loan term is up. An exit strategy isn’t compulsory otherwise because the bank only has a vested interest in the business during a loan term. Once the time is up and the loan is paid in full, the bank will not be concerned about the performance of the business because it has earned its compensation in full and has, therefore, exited at that point.
If you look towards a bank loan or other form of debt, the interest expense should be shown in your income statement/receipt, while your principal loan repayment would be shown in your cash flow statement. However, if you seek investment or another equity financing, the interest expense and principal loan repayment will be zero.
So, which type of funding should you consider?
There isn’t an accurate answer to this question. However, banks are open to giving you a loan for your business and the chances you will get the loan. However, when it comes to investors, they won’t invest until they find your ideas are outstanding and could disrupt the market.
Another factor to consider is your CIBIL score; the more your score is, the more chances of getting a loan from the bank. Anything between 700-900 is regarded as an excellent CIBIL score.
So with the above information, these are the Business Financing Options available, but all we can say is both are best in their own space. You need to see the interest rate or investors’ expected returns and choose between the two wisely.