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Bank Loans vs. Angel Investors – What Is the Right Way to Fund Your Startup?

Comparing bank loans and angel investment for starting a business

Bank Loans Vs. Angel Investors - What Is the Right Way to Fund Your Startup?

One thing that has prevented a significantly large number of aspiring entrepreneurs from taking the big plunge is funding. Regardless of whether you have a million or a billion dollar idea, the truth is that you may not be making any money during the initial few days or months of starting up. Unless you have a well-established source of funding, you do not really have the means to keep pursuing your business dreams. When it is time to pay the bills, ideas are not enough. That's one of the major reasons according to a Bloomberg why 80% of new businesses shut shop within the first 18 months.

Funding to set up a new business can come in a variety of ways. But two of the most popular channels are taking up bank loans and being funded by angel investors in exchange for equity. Interestingly, several entrepreneurs prefer angel investors to bank loans - the reason is that unlike loans, angel investments are in lieu of equity. So if you are running into a loss, you do not have to continue repaying the loan.

But such investments do not come so easily. For one, investors do not put in their money just for your idea. As is often said in the industry, ideas are dime a dozen. It is the execution that matters. So unless you have a past record to show, you are going to have few investors interested before starting up. What this means is that even if you want to secure an angel investment, you will have to show at least a bit of traction - something that is not possible all the time without funding.

It is here that bank loans come in handy. Unlike angel investments, bank loans are offered merely based on your capacity to pay. As long as you have a clean past record, bank loans are often relatively much easier to secure. So ideally, you secure a bank loan to startup and then could potentially go the angel funded route at a later stage when you start seeing traction.

However, not all businesses are made for such a roadmap. Marian Berege, an Australian entrepreneur and owner of Rianns Event & Wedding Hire company, small businesses as hers are often not ideal for angel and venture capitalists. The reason, she says, is because such investors often look at immensely huge returns, often on the lines of 100x or 200x their investment. For instance, if an investor puts in $200,000 in your company, they may want to see an exit when their equity stakes are worth a least $20 million. An event hire company cannot promise such exponential growth and revenue returns which means they are often not the target of equity-based investors.

On the other hand, it is not a good idea to carry too much debt either. According to Neil Kokemuller, the author of the book Marketing as a Business System, businesses that are funded entirely on debt put themselves at risk since unlike equity, debt has to be repaid on time - which means that even a couple of bad months could mess up your financial health. What more, because of these inherent risks, businesses that are funded by too much of debt are often shunned by other investors which makes future funding difficult.

The solution, as it is with every other thing in life, is in the middle. It is always recommended to have a healthy mix of equity and debt. Equity does not have to come from angel investors alone. With websites like Kickstarter becoming a popular phenomenon, there are instances where businesses get funded solely for the idea. So consider all these various options and pick a little bit of everything in order to protect your business from too many risks. After all, businesses take time to show results, and unless your financial health is in good shape, you cannot afford to give your business sufficient time to grow and make money.

More Stories By Harry Trott

Harry Trott is an IT consultant from Perth, WA. He is currently working on a long term project in Bangalore, India. Harry has over 7 years of work experience on cloud and networking based projects. He is also working on a SaaS based startup which is currently in stealth mode.