It is known that financing is one of the important business tools to achieve the set goals and successfully develop the company. It is great if a company can provide the necessary capital based on historical profits or working capital, however, for faster growth, the company may often need to attract external capital. There are two basic ways for a business to get money: either (1) borrow money or (2) raise equity and sell shares of the business to an investor. In the following article, we will mention how one type of financing differs from another and in which cases each one is better suited.

Loan for the company
A loan for a company is the simplest and also the most frequent way to attract additional funds to a business. When receiving a loan, there is a clear obligation to repay this money with a certain interest rate in a certain period of time. The main advantage is that the relationship with the recipient of financing is very clear and simple - the entrepreneur must return the loan and the relationship ends. Also, the loan provider does not get involved in the management of the company in any way, only through the terms of the loan agreement can certain limitations of actions be set.

The biggest disadvantage of loans is that if the company is unable to repay the loan, its owner will often be personally responsible for repaying the loan, or the creditor will be forced to sell the company's assets and property pledged to recover the debt. Respectively, the consequences of business success or failure are on the entrepreneur's own shoulders. Also, interest expenses and loan amortization create fixed and regular obligations, which can cause difficulties in case of rapid changes in circumstances.

There are three basic ways that a company can raise a loan : (1) in a bank, which is the most frequently used path; (2) from an alternative financier that can offer funds in situations where bank loans are not suitable or available and (3) bonds that can be traded both publicly on the stock exchange and offered to a limited group of investors.

Investments
Investment is the purchase of equity shares in a company. In this process, the company increases the total amount of the company's equity by issuing new shares (or shares), which are purchased by the new investor . This investor accordingly becomes a co-owner of the business and the success of this investment is closely related to the success with which the company manages to develop. An equity investor does not have to repay any specific amount as in the case of a loan, but makes a profit by hoping to sell his shares in the company at a profit in the future. It is also the main advantage of this financing that the success of the entrepreneur and the financing provider is closely linked and all responsibility is no longer solely on the shoulders of the business founder. It should be taken into account that the investor will want to participate in the main decisions of the company and will also claim dividends, according to the size of his shares in the company.

This is also the main drawback of this source of financing, which the entrepreneur has to reckon with. Respectively, the relationship between an investor and an entrepreneur is significantly closer and more intense than between a lender and an entrepreneur. Also, you can only "get rid" of the investor by selling the company to another investor/s.

Equity investments can be provided by specialized venture capital ( venture capital ) funds, as well as wealthy individuals or companies. Recently, more and more companies in the Baltic States also use the opportunity to attract investments by selling shares in their company publicly on the stock exchange.

How to choose which type of capital raising is more suitable
A loan for a company is more beneficial when the company is already working with a positive cash flow and the entrepreneur has reasonable confidence in the ability to repay the loan (income has stabilized). The loan can be used for the purchase of property and equipment, as well as for working capital and other short-term purposes, such as seasonality adjustment, stock purchase or the fulfillment of larger orders.

The first stop for a loan is usually a commercial bank, where the loan interest rate is likely to be the lowest. Credit from commercial banks is more suitable for financing long-term projects - the purchase of property or equipment. However, banks are more demanding about financial indicators, they have higher collateral requirements and financing evaluation takes longer. Therefore, the offer of alternative financiers is often more convenient for short-term goals. Moreover, in conditions of high euribor rates, bank loans are often already in line with the products of alternative financiers in terms of costs.

On the other hand, attracting an investor is more beneficial if the company is in an early or rapid growth phase or if the loan is not yet available. Also, investments are characterized by a more uncertain term of investment - usually three or more years, depending on the industry and the size of the company. Below are several instances where investment is likely to be the right type of capital:

• The company is new or in an early phase – the business cash flow is weak or unstable and capital is needed for, for example, product development, prototype production or the fulfillment of first orders. New companies will most often not qualify for a loan from a bank or other credit institution, so in the early phase investment or equity is the only way to develop. For the implementation of new ideas and product development, capital is allocated by organizations such as the Latvian Business Angel Network (LatBAN), various acceleration funds or private investors.

• Business needs money to significantly increase the company's volumes. In this case, the company must have previously proven itself as a profitable market participant, and the necessary money would help the company reach its maximum potential. To get that amount of money, you may often have to hire a professional management team, additional sales staff, or open new departments. Enable capital funds , such as FlyCap, BaltCap, Change Ventures and others, are most often used for this purpose

• The small business needs additional help in the field of management or contacts that would help to obtain currently unavailable resources. In this case, investors are the “smart money”. In other words, their value is higher than the value of money itself. They usually help companies find new customers or supplier channels. These types of partners are usually the previously mentioned business angels or other larger companies.

• The company does not qualify for the loan. It is important to remember that in order to receive a loan, the company's financial data must meet certain criteria, and the loan will not always be available. If the business is new, with negative cash flow, low equity, or if the owner has no assets to back the loan, then an investor may be the only way to raise more money for the business. Both business angels and private investors and business partners are suitable for this type of investment.

Where to look for funding
To discuss in more detail what type of capital is the most suitable for the company in a particular case, you are welcome to contact Capitalia's financing specialists. If we are unable to offer the capital we provide, we will always refer the entrepreneur to the most suitable financier in our opinion. Also, Capitalia has developed a free, convenient online tool to not only find out the best type of financing, but also to receive specific recommendations about the most suitable financier and its contacts.