Introduction
Starting a new business is an exciting and potentially life-altering adventure. But to turn your business dream into a reality, finding the money to make it happen is usually one of the most difficult parts of the startup process. Although there are many options available to finance a business, personal loans are what some entrepreneurs consider using to finance their businesses. But is that the best idea? Before drawing on personal loans for capital, it’s helpful to thoroughly assess both the benefits and drawbacks in order to make an informed decision as to whether this method meets your business plans and financial portfolio.
What is a Personal Loan?
A personal loan is an unsecured loan that individuals can borrow money for a variety of personal purposes, including paying off debt, financing large purchases, or financing emergency expenses. Personal loans are usually unsecured, and thus do not have collateral. Banks, credit unions, and online lenders are common institutions that offer personal loans. Borrowers receive a lump amount that is to be repaid over a set time, along with interest.
Most businesspeople view personal loans as a good source of financing for their startups since they are easy to obtain and less restrictive than business loans. Yet, leveraging a personal loan for business is not without its own risks and benefits that should not be ignored.
The Benefits of Utilizing Personal Loans for Your Business Startup
1. Quick Access to Capital
One of the major reasons entrepreneurs use personal loans to finance their business is the immediacy with which they can receive the funds. Business loans, particularly those from conventional banks, are often a time-consuming affair involving business plans, elaborate financials, collateral, and credit checks. Personal loans, by contrast, are usually approved very quickly. If you require funds in a hurry to capitalize on a business opportunity or pay for pressing startup costs, a personal loan might be a better option.
2. Less Documentation and Requirement
Personal loans generally require fewer qualification criteria than business loans.
For a business loan, the lender will usually ask for a comprehensive business plan, tax returns, and financial reports that show your startup’s potential and ability to repay.
With personal loans, the lender can only ask for basic data regarding your finances, such as your credit rating, income, and current debt. This ease can be convenient in accessing funds and even quicker, especially if you possess a good credit history.
3. Unsecured Loans with No Collateral
One of the best things about personal loans is that they are generally unsecured, which means you don’t have to pledge personal assets, like your house or car, as collateral. This is especially helpful for people who don’t have assets of the right value or who don’t want to risk personal property.
The lack of collateral ensures that you will not risk losing valuable assets if your business collapses or you cannot repay the loan.
4. Freedom in How You Spend the Money
Personal loans tend to provide more freedom in how the money is spent. Whereas business loans have certain limitations on how you can spend the money (e.g., buying inventory, financing equipment, etc.), personal loans have very few limitations, and you can spend the money as you wish. Whether you want to borrow employees, fund marketing campaigns, purchase office supplies, or cover the costs of operation, the adaptability provided by a personal loan can help make it simpler to fulfill your varied demands as a new entrepreneur.
5. Lower Interest Rates Possible
If you have good credit, you might be able to obtain a personal loan with a comparatively low interest rate. For those with a high credit score, personal loan interest can be significantly lower compared to business loans or credit card interest rates. This can assist with lowering the overall cost, making it easier to repay the loan and not overstretch your finances.
The Disadvantages of Using Personal Loans for Your Business Startup
1. Risk of Personal Liability
Perhaps the biggest disadvantage of using a personal loan to finance a business is the risk of personal liability. Because personal loans are not secured, if your business does not succeed and you cannot repay the loan, you could be held personally liable for the debt.
This can have serious financial implications, impacting your personal credit rating, and even put your assets, like your house or vehicle, at risk.
This risk is one of the primary reasons why so many business owners opt for alternative finance sources, such as business loans or investors.
2. Effect on Personal Credit
Using a personal loan to finance your business entails taking on extra personal debt that might harm your personal credit rating.
If you cannot manage to make loan repayments, your credit history might be negatively affected, and this can further complicate your ability to get credit in the future—both for business and personal purposes.
In addition, if you already have a lot of debt, lenders might consider you a riskier borrower, which means your opportunity to get more funding for business growth or personal use decreases.
3. Limited Borrowing Capacity
Personal loans typically have lower borrowing caps than other business loans. Whereas business loans can provide ample amounts of cash to finance big projects or major operating costs, personal loans can only offer some fraction of the capital your startup needs.
Should your business need to fund large equipment purchases, inventory, or payroll, a personal loan might not be enough.
In such situations, you might be required to take further loans or sources of financing, which may cause complications and more debt.
4. Poorer Interest Rates for Bad Credit Borrowers
If you have a poor credit history, you could be offered higher interest rates when you take a personal loan. This can easily hike the borrowing cost, making repayment of the loan even more challenging and weakening the financial well-being of your company.
In this case, you might realize that a business loan with better terms would have been preferable.
Further, some personal loans carry fees and charges that add to the total repayment cost, which also puts additional pressure on your company’s finances.
5. Financial Burden and Risk of Debt Overhang
Borrowing a personal loan to finance your business implies having to make regular monthly payments, usually over several years. This will strain your personal finances significantly, particularly if your venture does not create early cash flows. If the business fails as intended, you could be finding it difficult to meet loan repayment, with additional personal financial pressures added to the problems of operating a business.
In the worst-case scenario, this could result in financial stress, personal bankruptcy, or other serious outcomes.
6. Limited Growth Potential
Since personal loans tend to be smaller than business loans, they might not have the financial resources to grow your business in the long run. For a startup to expand, it usually needs access to higher levels of capital over time. If you depend only on personal loans, you could restrict your capacity to expand your business, recruit more staff, or invest in new technology and infrastructure.
Seeking Alternatives to Personal Loans for Business Financing
While personal loans can be an easy and convenient source of funding for small business start-ups, they are not necessarily always the best or most viable option in the long run. Entrepreneurs who wish to establish a healthy financial base for their business may wish to seek alternative financing options that offer added security and less personal risk.
Here are some alternatives to personal loans that may be worth exploring:
1. Business Loans
Conventional business loans are among the most popular means of funding a startup. Business loans are usually provided by banks and other financial institutions, and they are tailored for business use. Business loans tend to have better terms than personal loans, such as higher borrowing limits and possibly lower interest rates.
The process of applying for a business loan tends to be more exhaustive, involving extensive documentation, a business plan, and financial projections. However, the amount of funding that can be offered can be larger and more suited to the requirements of a developing business. Additionally, since business loans are collateralized against the business, your personal assets will not be jeopardized in the event that the business collapses, subject to the nature of the loan.
2. SBA Loans
The Small Business Administration (SBA) provides government-backed loans to small businesses. SBA loans tend to have favorable interest rates and longer repayment periods, which make them an appealing choice for entrepreneurs requiring funding for their companies. Although it takes a while to apply for an SBA loan, which demands comprehensive documentation, SBA loans aim to make financing accessible to small businesses, particularly those with businesses that may be perceived as risky by traditional lenders.
Some of the most well-known SBA loan programs are the 7(a) Loan Program, the 504 Loan Program, and the Microloan Program, which address various business requirements like equipment acquisition, working capital, and real estate purchase.
3. Crowdfunding
Crowdfunding is a fast-growing way of raising capital for companies. Websites such as Kickstarter, Indiegogo, and GoFundMe enable entrepreneurs to raise capital from a wide audience of individual investors who are willing to support new products or concepts. Crowdfunding enables you to raise capital without incurring debt or surrendering equity in your company.
One of the most important benefits of crowdfunding is that it can also be used as a marketing vehicle. By making people passionate about your service or product before it’s even out, you can create a base of loyal followers and brand evangelists. Crowdfunding does have its downsides, though. It usually takes a successful marketing campaign in order to raise the kind of support necessary, and there is no assurance that your campaign will be a success.
