Learn how to compare and choose between different loan and equity terms for your business funding, based on factors like interest, equity, risk, flexibility, and alternatives.

Selling equity shares reduces founders' control and a share of future profits. However, equity financing allows startups to grow much faster with outside capital. The key is striking the right balance between selling just enough equity to fund growth while maintaining as much ownership as possible. Entrepreneurs need to value their company properly when seeking investors so they don't sell too much equity and face excessive dilution.

Calculate the annual percentage rate (APR), not just the stated rate. The APR reflects total costs including fees. Upfront fees increase real borrowing costs. Don't just focus on the interest rate alone. Understand the grace period before repayment starts. This offers flexibility in timing initial payments.

How do you evaluate loan and equity terms?

When you need funding for your business, you may have to choose between loan and equity terms. These are different ways of raising capital that have different implications for your cash flow, ownership, and risk. How do you evaluate which option is best for your situation? Here are some factors to consider.

1 Interest rate and repayment

A loan is a debt that you have to pay back with interest over a fixed period of time. The interest rate reflects the cost of borrowing and the risk of default. A higher interest rate means more expensive financing, but also more flexibility to use the funds as you wish. The repayment schedule determines how much cash you need to generate to service the debt and how long it will take to pay it off.

Add your perspective

Andrew Lokenauth

I write TheFinanceNewsletter.com for 90,000 subscribers ➖ Follow to get smarter with your career, finances, and life ➖ 15yrs in finance helping 2 million+ followers
Report contribution
Calculate the annual percentage rate (APR), not just the stated rate. The APR reflects total costs including fees. Upfront fees increase real borrowing costs. Don't just focus on the interest rate alone. Understand the grace period before repayment starts. This offers flexibility in timing initial payments.

Like

2 Equity stake and dilution

Equity is a share of ownership in your business that you give to investors in exchange for funding. The equity stake reflects the value of your business and the potential return for the investors. A higher equity stake means more funding, but also more dilution of your control and profits. The dilution effect depends on the valuation of your business and the terms of the deal, such as voting rights, dividends, and exit options.

Add your perspective

Andrew Lokenauth

I write TheFinanceNewsletter.com for 90,000 subscribers ➖ Follow to get smarter with your career, finances, and life ➖ 15yrs in finance helping 2 million+ followers
Report contribution
Selling equity shares reduces founders' control and a share of future profits. However, equity financing allows startups to grow much faster with outside capital. The key is striking the right balance between selling just enough equity to fund growth while maintaining as much ownership as possible. Entrepreneurs need to value their company properly when seeking investors so they don't sell too much equity and face excessive dilution.

Like

3 Risk and reward

Both loan and equity terms involve trade-offs between risk and reward. A loan is a fixed obligation that you have to repay regardless of your performance, but it also preserves your ownership and upside potential. Equity is a variable outcome that depends on your growth and profitability, but it also reduces your liability and aligns your interests with the investors. The risk and reward balance depends on your stage of development, your growth prospects, and your risk appetite.

Add your perspective

4 Flexibility and alignment

Another factor to consider is how flexible and aligned you are with your funding source. A loan gives you more freedom to manage your business as you see fit, but it also limits your ability to adapt to changing circumstances or pursue new opportunities. Equity gives you more access to resources and expertise from your investors, but it also requires you to communicate and collaborate with them on strategic decisions. The flexibility and alignment factor depends on your vision, your culture, and your relationship with your funding source.

Add your perspective

5 Alternatives and combinations

Finally, you should also explore other alternatives and combinations of loan and equity terms that may suit your needs better. For example, you may consider convertible debt, which is a loan that can be converted into equity at a later stage, or revenue-based financing, which is a loan that is repaid as a percentage of your revenue. You may also combine different types of loan and equity terms to diversify your funding sources and optimize your capital structure. The alternatives and combinations factor depends on your goals, your market, and your negotiation skills.

Add your perspective

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

Add your perspective

How do you evaluate loan and equity terms?

1

2

3

4

5

6

1 Interest rate and repayment

2 Equity stake and dilution

3 Risk and reward

4 Flexibility and alignment

5 Alternatives and combinations

6 Here’s what else to consider

Entrepreneurship

Rate this article

Thanks for your feedback

More articles on Entrepreneurship

More relevant reading

How do you evaluate loan and equity terms?

1

2

3

4

5

6

1 Interest rate and repayment

2 Equity stake and dilution

3 Risk and reward

4 Flexibility and alignment

5 Alternatives and combinations

6 Here’s what else to consider

Entrepreneurship

Rate this article

Thanks for your feedback

Explore Other Skills