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Should startups consider loans instead of VC money?

“If you’re starting a business and you take out a loan, you’re a moron,” said firebrand entrepreneur Mark Cuban in an interview with Bloomberg,

However, if you’re a budding entrepreneur, hearing or reading such things from sharks can be disheartening, especially if you’re looking to start with little to no capital. To be fair to Cuban, he did go at length saying that businesses can be launched through sheer effort. Nevertheless, it takes money to make money, even just to make it through the day.

There are, however, key instances where additional significant funding may be needed, for example, when business suddenly picks up and you have to ramp up production to keep up with demand. You’d definitely want to take advantage of such opportunities.

In these situations, is getting a small business loan really that bad of an idea? And is it less viable compared to getting venture capital (VC) funding?

Pros and cons

Loans and investments, both options have their pros and cons. VC funding can provide a significant amount of capital. Partnering with a VC can also boost the profile of your business. VCs can also offer mentorship and their networks to help you grow the business. However, in exchange, you sell part of your company. VCs will often insist that they be involved in decision making so a key tradeoff is your independence.

In contrast, loans allow you to keep 100 percent of the business. They can be granted rather quickly in a matter of days. However, loans have to be paid back at a regular schedule and this means you have to consider loan payments into your cash flow. Collateral may also have to be used to secure the loan. In case your business doesn’t pan out, you still owe the money.

Choosing between the two can be a tough decision. You should consider your specific situation and vision you have for your company. With its advantages, you can’t entirely disregard loans especially if you want to retain control over your business. As an investor, Cuban surely has no problem buying out stakes in businesses so it does serve him more to downplay what loans can do.

It’s also easy to overlook that partnering with a VC is no quick deal. To start, your business has to offer something really unique and valuable before a VC would even consider investing. You should also have a solid business model and plan. Growth projections and sales figures also matter since they will expect return on their investment. That could put more pressure on your business. VCs would have to check all of these before they even greenlight the deal.

Fintech makes funding easier

The process of getting small business loans has gotten much easier thanks to financial technology (fintech). A number of lenders may still shy away from granting loans to startups but a growing number of the larger and more progressive banks attractive small business loan products. Loan approval rates for small business loans are on the upswing.

You may think that bank loans are too much of a hassle due to the amount of documentation required just to apply. However, banks are now adopting new technologies to speed up the loan application process.

There are also non-bank fintech lenders. Peer-to-peer lending platform Lending Club offers business loans up to $300,000 granted that other users would deem your business attractive enough to grant you a loan. You can also consider using crowdfunding through Kickstarter and GoFundMe which has already worked for several creative efforts.

All of these methods would allow you to secure additional capital without having to sell part of your business.

Plan for sustainability

Getting external funding is a major decision for any entrepreneur. Despite the bad rap business loans have, the advantage of retaining complete control over your company is compelling enough for many to opt for this option. You just have to be smart with your finances and evaluate if you are building your business at a sustainable pace. Here are some pointers to guide you.

Know whether you really need funding. Ask yourself why do you need the additional funds. Are you struggling to meet demand? Is there a massive opportunity that you couldn’t afford to miss out on? If these are the reasons, then your business may be strong enough for you to manage a loan. But if you’re looking for funding because you’re struggling to fund your operations, there may be deeper underlying causes that you should address first. In such cases, a loan may just be another hole you’re digging yourself into.

Go slow and steady. Excited entrepreneurs often desire to make a massive splash from the start. As such, it’s tempting to seek out funding in order to splurge on more people or fancy equipment even if they’re not truly essential at that stage of the business. There are many businesses that succeeded because they opted for a sustainable pace. They keep costs at a minimum and completely bootstrap their operations. If ever they took out loans, it was because they knew they could generate more than enough business to pay the loans back.

Explore other options. You may not look too far to look for people who believe in what you’re trying to do. You can always ask family to lend you money. However, just be aware that personal loans from family and friends mean you’re risking the personal relationship alongside their money. Don’t play with your relative’s retirement, college, or emergency funds. Besides, you can always look for alternatives such as government grants and tax breaks to ease your cash flow.

Have a plan to pay it back. If you decide to take out a loan, you should be prepared to pay it back. Keep in mind that you will be accountable for the loan even if your business folds. So review your cash flow so that you will know how much and for how long the terms of the loan should be. Even if one bank approves your application, don’t be afraid to shop around for more favorable rates. Consider non-banks and fintech services as well.

Be wary of certain lenders. Financing companies specifically target those who can’t get bank loans. Many of them don’t require as much documentation and can release money quicker in exchange for much higher interest rates. Some of them are quite predatory. There are laws that regulate rates and outlaw predatory lending so you just have to be sure to read the terms and study the fine print.

Be realistic. If no bank will take you on as a client even just for an overdraft or line of credit, take it as a sign that you may be doing something wrong with your business. Don’t be afraid to step back or even hit the pause button to rethink your direction before jumping into commitments that could break you in the future.

Whether you decide on getting a loan or getting an investor on board, always keep in mind that it’s not free money. There will be strings attached. Don’t think that you can now go out and buy yourself something nice. Either way, you have to pay that amount back in one form or another.

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