When you have a business that needs money, there are generally two basic choices available to you:
- Borrow it - from a lender such as a bank
- Find an investor
Another common term for money in the context of either borrowing or investing is the word: Capital.
Borrowing
When you borrow, it’s important to recognize that the Bank or Lender does not own any part of your business.
They will just lend you money and charge a rate of interest as payment. The rate of interest that lenders charge will typically vary in proportion to the level of risk associated with you and your business and the actual amount of money that you wish to borrow.
Lenders are concerned about the ability of your business to repay the loan and the interest, the quality of the management and the strength of the collateral that you can out up to guarantee the loan. Borrowing is also commonly termed: Financing.
When you or your business borrows money from a Bank (or other type of Lender), the Bank typically provides you with a Term Sheet which details the terms and conditions under which the Lender is prepared to advance you (the Borrower) the loan in question. Common terms and conditions in a Term Sheet include:
- Amount of the Loan
- Rate of Interest
- Repayment Terms
- Collateral pledged (if any)
- Fees and charges
- Remedies in the event of Default
Its also important to note that while Lending money does not require the giving up of any onwership in your business, many Banks or Lenders will require a lien or charge over your business assets as collateral to ensure you repay the loan. We call these loans: Secured Loans and we explain these in more detail in the Finances section of Biz 101.
Investing
We contract this to Investors who give you money in exchange for owning some (or most!) of your business.
When a person gives you money in exchange for ownership of your business, they are an investor or part owner of your business. As part owner, they will have a vested and legal interest in how your business performs.
They will be entitled to have a say on many of the aspects of the business – which will no longer be “your” business, but “our business”. Investors are typically issued Common or Preferred Shares in a business.
They generally make money from their investment in the form of the distribution of profits from the business to shareholders, called: Dividends; and by the eventual sale of their shares to either you or other 3rd parties.
Having shareholders requires the preparation of a Shareholders Agreement which address many of the issues or concerns business owners would have, such as compensation, voting and the appointment of directors & officer.
There are many different types of investors. These include:
Angels
An angel investor is typically an investor that provides money (or capital) to startup or early stage companies. This is also sometimes referred to as Seed Capital.
In addition to providing seed capital, an angel investor is often a seasoned business person that has successfully run a business and can also play the role of a business mentor. Angels also often have a “rolodex” of contacts that they can introduce you to which can help grow and develop your business.
Venture Capital (VC’s)
VC’s typically provide money to companies once they are past the startup or early stage and are in a high growth part of their business life cycle. They tend to make investments in companies that they have a clear idea of how they are going to exit from their investment in the 5 to 10 year future time frame and often work with companies that raise capital by selling their shares to the general public (called: an IPO or Initial Public Offering).
IPO (Initial Public Offering)
In this scenario, a business offers it shares to the general public and its shares then trade on a stock exchange.