Small businesses come in all shapes and sizes, but they all need to secure funds to start, grow, and scale their operations. In my work as a Business Plan Advisor, I help business owners develop and refine their business plans. These invaluable documents serve as a roadmap for the future of their businesses and are essential in securing early-stage financing.
Whether you approach a financial institution for a loan or seek investment to secure the funds you need, you should understand each path and its advantages and disadvantages.
What’s the Difference Between Lenders and Investors?
A lender, such as a Bank or Credit Union, agrees to give you money to use on your business with the understanding that it will be repaid over a set term, with fixed interest. The lender doesn’t get a share of the business profits, they only care about your ability to repay the loan. The only way the lender loses out is if the business defaults on the loan and the borrower can’t meet their payment obligations.
In contrast, an investor gives you money in exchange for a specific percentage of the business. If the business is doing well, they profit from the success. But if the business is struggling, they aren’t owed anything. This means that they share the risk with the entrepreneur.
What Are the Two Types of Loans Available From Lenders?
It’s important to differentiate between the two types of loans that lenders may provide:
1. Asset-Backed Loans
Since lenders want to remove as much risk as possible from a loan, they’ll often request collateral in the form of a personal or business asset. Should the borrower be unable to repay the loan, the asset is then sold off to pay the debt. These loans are called Asset-Backed Loans.
2. Character-Based Loans
Any loan that isn’t asset-backed is referred to as a Character-Based Loan. These loans are given based on the character of the entrepreneur. Although these types of loans are preferable, they’re riskier for the lender, so they tend to only be available in smaller amounts.
In British Columbia, VanCity, Futurpreneur, and WeBC are three organizations that offer this type of loan to entrepreneurs.
What Do Lenders and Investors Look for in Businesses?
The most important thing a lender looks for is low risk. All that matters to them is that their loan is repaid. It doesn’t matter if the business makes millions of dollars, or just breaks even, they want certainty.
The priorities of an investor differ from those of a lender. While they try to minimize the risk to their investment, they’re more risk-tolerant if there’s strong potential for growth and return on investment.
An investor will often have a stake in several businesses and have accounted for the possibility that one or two of their investments may not pay off. They use the profits they receive from successful business investments to offset any losses they might incur.
How Important Is a Business Plan for Attracting Lenders and Investors?
Whether it’s a lender or investor, a business plan is one of the most important factors in attracting funding for a business. Not only does it show your future plans for your business, but it also highlights that you’re diligent, trustworthy, and driven.
The more information you can provide, the more likely you are to secure the financing you need. A business plan allows you to explain in detail what the business will accomplish in the medium- to long-term and the actions you’ll take to do so.
Equally as important is a cash flow projection. This will show the financial implications of these decisions. All lenders, and most investors, will need to see a business plan and cash flow projection before providing financing.
How Can You Make Your Business More Attractive to Lenders and Investors?
For lenders, highlight how reliable your plan is and how much thought you’ve put into it. They’re looking for the safest, most secure businesses, so they know they’ll be paid back without any fuss.
For investors, focus on your growth potential and how you plan on reaching your targets. They want to know what’s going to happen if the business is successful and how much growth you think you can achieve.
In general, you should pay attention to small details and demonstrate knowledge of every aspect of your business. You can develop different versions of your business plan specifically for lenders and investors. The facts remain the same, you just choose to place extra importance on areas they’ll focus on. Knowing your audience when writing your plan is essential.
Can Businesses Receive Funding From Lenders and Investors?
Lenders and investors look for different things in businesses. These types of financing often occur at different phases in the life cycle of a business.
For example, certain high-growth businesses may not be eligible for lending early on, as they’re viewed as too risky. They either haven’t shown a path to profitability, or they haven’t fully developed their product. An investor might be drawn in if they see potential for long-term growth. Once that business has proven itself, it can tap into lending down the road, if needed.
How To Choose Between Lending and Investing?
Investors have a share in the profit of a business, so it makes that type of financing potentially more expensive for a business owner. As a result, it would be beneficial to investigate lending first.
You’ll always go into a lending arrangement, knowing how much you’ll have to pay. Assuming your business is successful, this is the cheaper option. When lending isn’t possible, either because it’s too early or seen as too expensive, that’s when it’s a good idea to consider investment.
Small Business BC is Here to Help
SBBC is a non-profit resource centre for BC-based small businesses. Whatever your idea of success is, we’re here to provide holistic support and resources at every step of the journey. Check out our range of business webinars, on-demand E-Learning Education, our Talk to an Expert Advisories, or browse our business articles.
