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This post came from a question on Quora that was likely geared towards a tech startup. These same principles, however, apply to all small businesses that are considering taking investments from friends or family, an equity crowdfunder, or other investment resources in addition to considering bank loans.
Borrowing vs. Opening Up for Investment: What’s the Right Path?
Of course there’s no right answer here because so much depends on the specifics of the opportunity, your preferences, the relationship with the investors or lenders, and the realistic options you have. Here are some considerations:
1. Do you even have the option of mainstream borrowing? Mainstream lenders (banks) can’t lend on a business plan. You need to pledge real assets, like home equity.
2. There are non-mainstream debt options, such as enlightened angel investors who will do a debt deal. That’s the exception not the rule, but it can be a good fit. They’ll want higher interest and probably an equity kicker, but still.
3. Investors aren’t a short-term solution to anything; they’re a marriage. Good compatible investors can be a huge benefit, while the wrong investors can be pure hell and destroy your business. They aren’t a homogenous group. Which investors matters a whole lot.
There’s a whole lot to be said for owning your own thing. When it’s a struggle it can be really hard, but if you make it, then you don’t have to share decisions with anybody or explain too much. You can bet on hunches. “God bless the child that’s got its own.” I speak from experience: my wife and I own a company with 40+ employees, positive cash flow, no debt, and we own it outright. That’s a great ending, but it did mean surviving some very dark days in the formative years.
4. Don’t forget you can go from debt to equity and back again, if you do it right, and you work with compatible people. Angel investors often give you convertible debt that becomes equity if you don’t pay it off, but gives you the option of repaying the debt and keeping your equity. Another piece from experience is that in my company’s middle years — we were already profitable and cash-flow positive and sales > $5 million — we took in VC money. They were good people and good partners, so it went well but in a few years we had incompatible goals, so we bought them out. Everybody remained friends.
5. Don’t reject the option of scaling the plan down a bit, growing more slowly perhaps, but refocusing to take less startup capital and make it something you can own yourself. The media and mainstream startup gurus tend to sneer at this, but it’s often the best option.
6. Look for the sweet spot in your startup, the right amount of money, what you really need. Don’t let the lack of investment spoil a great opportunity, and don’t encumber yourself with investors if you don’t need them and lack of investors won’t really hurt the business.
This article was originally written on July 29, 2014 and updated on August 25, 2016.