Private Equity Investments vs. Business Loans: What You Need to Know

Eventually, every small business owner or entrepreneur wants to grow their business. To do so, you need small business funding. There are two main sources of financing: private equity investments and small business loans. Here, we’ll look at the difference between the two to help you do your due diligence about which may be best for your business.

In this article:

• Learn the difference between private equity investments and business loans.
• Explore some of the best equity financing options for startup businesses and more established ones.
• Assess private equity vs. loans to determine what’s right for your small business.

What are private equity investments?

Private equity investments are an investment vehicle to help entrepreneurs and small business owners fund their business needs. A private equity investor may be any individual or organization that funds a private or public business in exchange for an ownership share of the company.

Investors may be from private equity firms, private equity funds, angel investors, venture capitalists, or even friends and family interested in diversification of their investment portfolios. The business gets access to the funding it needs, while the investor gains growth equity that may translate to larger profits if the business does well.

What is a private equity fund?

A private equity (PE) fund refers to a fund or group of investment funds that invest in or purchase privately owned small businesses. In some cases, private equity funds may invest in public markets, steering money to public companies listed on the stock market.

A PE fund isn’t a realistic business financing option for most small businesses as they tend to work with mature companies. After private equity deal value hit record highs in 2021, research from Bain and Capital has found that the number has significantly dipped in recent years. Private equity fund managers want significant growth equity and value creation from their general partners. Their investment strategies, therefore, generally focus only on businesses that have maximized profitability for a long time. They may also consider geographical regions, like if a company has a presence in European or Asian markets, as a means to expand their investment portfolios.

Private equity funds usually take a significant, sometimes majority, ownership stake in the business where the investors participate in making business decisions about daily operations.

Some of the world’s largest asset management companies, like Blackstone and Carlyle, operate private equity funds.

What are angel investors?

Angel investors are private investors who provide funding to small businesses in exchange for ownership equity, like private equity firms. However, the difference is that angel investors are individuals, not part of a larger firm.

Historically, angel investors have been known to be people with a high net worth who look for startup businesses and small private companies with the potential for significant growth they likely won’t find in public equity. Accepting funds from an angel investor may be a one-time arrangement or an ongoing agreement with defined time or maximum fund parameters. Unlike private equity funds, however, angel investors usually have a limited partnership rather than a majority ownership stake.

Startup businesses often prefer to work with angel investors over private equity firms because eligibility requirements and financing qualifications may be fewer. Angel investors choose which businesses to give money to based on personal relationships, personal preference, or which business plans pique their interest. If a new business idea, funded by an angel investor, takes off, then the angel investor stands to make a profit.

Like any equity financing arrangement, angel investors make money when your company makes money. There are no interest payments like a small business loan or a specific repayment schedule. Angel investors may or may not participate in decision-making, management, and operations.

What are venture capitalists?

Venture capitalists are equity investors, like angel investors, who finance growing businesses in exchange for equity in the company based on an initial valuation. These types of investors may work alone and invest personal funds into the business, or more commonly, they are part of a venture capital firm. Venture capital firms are made up of a group of investors that combine their finances into an investment pool intended to finance other businesses.

Venture capitalists typically seek out businesses that have demonstrated intriguing past performance and great potential to become even more lucrative. Their initial investment is typically more than $500,000, so the amount of equity they seek is higher. Since these investors typically operate as corporate entities, the selection process is more formal than with angel investors, and you may have to accept an investment management team. Venture capital firms often seek to invest in specific industries, like social media, real estate, technology, or finance, and may not be open to startup entrepreneurs.

What are small business loans?

Small business loans are a type of financing in which the small business owner borrows capital from a traditional lender, like a bank or credit union, or an alternative lender, like an online lending marketplace, and repays the loan according to a formal loan agreement. There are many different types of loan products intended for business financing, each with its own eligibility requirements, maximum loan amounts, and loan terms.

Term loans

A term loan is a type of loan in which approved borrowers receive a lump sum allocation upfront and then make monthly payments of interest and principal to the lender. Term loans can be secured, where some form of collateral, usually business assets, is held by the lender, or unsecured.

This loan type appeals to small business owners because it offers the full loan upfront and can be repaid early, sometimes with little or no prepayment penalty. Small businesses may be eligible for either long-term or short-term business loans when choosing a term business loan.

Business lines of credit

A business line of credit is revolving credit, like a business credit card, where the lender approves a maximum amount of credit. The borrower can then withdraw funds quickly whenever they experience cash flow shortages. Interest is paid only on the amount of funds that have been withdrawn, so payments remain reasonable. Having a line of credit allows small business owners to have instant access to capital without sustained debt.

SBA loans

SBA loans are a type of business financing where the funds are partially guaranteed by the U.S. Small Business Administration. SBA loan programs, like the SBA 7(a) loan, disaster loans, or microloans, can be used to increase working capital, make large purchases, refinance high-interest debt, and more. Borrowers often choose SBA loans if they can meet the strict approval requirements and lengthy application process because they offer low down payments, lower interest rates, and long repayment terms.

Which is the better business financing option?

When it comes to private equity vs. loans, the best source of business financing is not as simple as ranking funding opportunities. The type of financing that is best for your small business is the one that allows you to meet business needs, achieve your goals, and not negatively impact the business’s future.

When researching business lending and investing opportunities, consider the following advantages and disadvantages of each type of financing.

You may also like: revenue based business loans

Advantages of private equity

Whether you secure funding from an angel investor, venture capitalist, or private equity firm, equity financing has pros and cons.

• Fast access to capital: Since there is no formal application process for investors seeking alternative investments, finding funds through friends and family, a PE or venture capital firm, or crowdfunding may be much faster than loans.
• Less risk: There is no repayment of investment funds expected if the business fails to become profitable.
• Potential for additional funding: Investors often act as limited partners willing to do whatever it takes to enable success, including putting more money into the business should you become illiquid.
• Business guidance: Investors come with industry knowledge and can provide expert help to entrepreneurs in the early stages of business.
• Buyout options: Angel investors, portfolio companies, or private equity firms may offer to buy your ownership stake, which could get you a lucrative exit to fund your next venture.

Advantages of small business loans

Working with a traditional lender or an alternative lender, like Biz2Credit, to secure a small business loan can benefit an entrepreneur in the following ways:

• Build business credit: Lenders report payment activity to credit bureaus, so taking out a business loan or line of credit can improve your business’s credit score.
• Straightforward repayment terms: When a lender issues business funds, there are clear repayment terms listed in the loan agreement so borrowers know exactly how much money they will repay.
• Independence: While lenders may review business plans during the approval process, they do not participate in day-to-day business operations, as they do not hold an ownership stake.
• Early repayment: Business loans can be paid off at any time, although some loans include a prepayment penalty, so if profits exceed expectations, you can end the financial obligation early.

Disadvantages of securing capital through private equity

Working with a venture capitalist or other type of investor also has some disadvantages including:

• No limit: There is no limit on the return the investor can collect since they have purchased equity in your company and will receive a set percentage of profits forever.
• Scarcity: Investors are hard to find, especially for startup entrepreneurs and new businesses, since they are typically looking for a very specific type of company to invest in.
• Giving up control: Accepting financing from an investor means you may have to yield control over some or all of the business decisions.

Disadvantages of using a small business loan for funding

Small business loans are the most common type of business financing, but that does not mean there aren’t disadvantages to taking out a loan.

• Eligibility requirements: Loan qualification requirements may include annual revenues, time in business, and business credit history that limit their accessibility.
• Collateral or personal guarantee: Lenders may require you to secure a small business loan by offering up business or personal assets that the lender may take if you default on the loan.
• Restrictions: Borrowing money from a business lender may include restrictions on the use of the funds, like in the case of SBA loans or equipment financing.

Conclusion

Finding the right business financing can be the key to starting and running a profitable business. To secure the capital needed to achieve your business goals, consider the advantages and disadvantages of private equity investments versus small business loans. While private investors offer money that doesn’t need to be repaid, they will have an ownership stake in your firm, which may mean giving up some decision-making power. Small business loans are the more common source of financing, in part because of the diversity and availability of unique loan products, like term loans and SBA loans.

If your small business needs funding, contact Biz2Credit to learn about the best financing options for your business needs. Ray Vasquez, owner of Johnny Rockets Sports Lounge was able to secure the startup capital he needed to turn his business dream into a reality by working with Biz2Credit’s expert financing team.

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