Why do small businesses fail?
In most cases, it’s because of a lack of capital. According to a U.S. Bank study, 82% of small business failures occur due to cash flow issues. As a business owner, you understand the importance of cash flow. That’s why you take steps to ensure that your business has enough money to continue its operations as usual. That’s also likely what brought you to consider a personal loan for business. You may be asking yourself: Is taking out a personal loan for my business a good idea?
Wonder no more. In this article, we’ll highlight the pros and cons of using a personal loan to support your business. Equipped with this knowledge, you’ll be able to make the best, most informed decision for your company.
When you think of the top funding sources for startups and small businesses, you may think of angel investors, venture capitalists, and banks. After all, they’re the ones that make the headlines. But according to data from Fundable, the largest source of startup funding is the founders’ personal savings and credit (57%), while the next largest source is family and friends (37%). Many business owners use personal loans to support their companies—especially in their early stages. This method of funding has its advantages. So, let’s take a look at four of the pros of using a personal loan for business purposes below.
According to a Federal Reserve study, 58% of businesses less than two years old have trouble obtaining credit or money to grow. Simply put, obtaining a business loan can be difficult for many small businesses, in part because of the collateral requirements. A personal loan can serve as an alternative funding option if you’re having difficulty securing cash in other ways. One of the biggest perks is that when you apply for a personal loan, the lender only analyzes your credit history and income—not the company’s balance sheet. Moreover, it’s easier to be approved for a personal loan than other types of loans. Experian, one of the major credit bureaus, states that even those with lower credit scores can get a personal loan (though a score of 670+ will present you with more options and better terms).
Business lenders examine many factors when considering you for a loan (including your credit, your company’s credit, current company finances, etc.). This makes the underwriting process more time-consuming. If you want a Small Business Administration (SBA) loan, which often has more favorable terms, the process can be much longer: SBA loans can take 60–90 days to process! Compare that to the timeframe for personal loans. Some lenders can fund loans within 24 hours. If you need capital fast, a personal loan may be a good option for your business.
In most cases, you’ll need collateral to secure a business loan. According to ValuePenguin, the most suitable collateral is business property, such as equipment, buildings, inventory, and vehicles. For that reason, when you take a business loan, you put your business’ property at risk. With a personal loan, on the other hand, you don’t have to put up collateral (as long as you apply for an unsecured loan). That minimizes risk for your business.
When you are approved for a business loan, the funds you receive come with conditions that dictate how they can be used. For instance, a CDC/504 Loan from the SBA can only be used for equipment and real estate. Whether you’re interested in covering payroll, increasing your inventory, or investing in advertising, the flexibility that comes with a personal loan allows you to allocate capital to your business more effectively.
While personal loans can provide you with a way to access capital and grow your business, that money doesn’t come without potential risks. You must understand those risks before signing on the dotted line. As previously mentioned, the most common cause of small businesses failing is the lack of adequate capital. And one of the main reasons for cash flow becoming an issue is when businesses take on too much debt. You don’t want to get into that situation. Take a look at these five cons of using a personal loan for your business before deciding to apply.
A personal loan is based on your credit history and income. Repaying that loan, however, depends on your company’s performance. If your company experiences a slowdown in revenue (as many businesses have during the COVID-19 pandemic), you may get behind on payments—or even default. This would hurt your credit score. And taking a hit to your credit score can make it difficult for you to qualify for a good mortgage, auto loan, or other forms of personal credit.
So, if you don’t want to risk your personal credit, you may want to avoid using a personal loan for your business.
Personal loans typically range from $1,000 to $50,000. While it’s possible to get a larger personal loan (some may offer up to $100,000), it’s not a guarantee that you’ll get all the funds you need. If your company requires a lot of capital to run, a personal loan may not provide you with enough money. Other sources of funding may be more suitable for your business.
Your personal loan’s interest rate depends largely on your credit score. The rate you’re offered can vary widely depending on your situation. If your credit isn’t the best and you have outstanding loans at the moment, your personal loan’s APR could be quite high.
According to the SBA, the interest fees you pay on business loans are tax-deductible. Unfortunately, that’s not the case with personal loans. When comparing a business loan with a personal loan, be sure to factor in the tax benefit of deducting the interest you would pay on a business loan. This will help you see which form of financing is truly the most affordable.
While not all personal loans require collateral, some do. If you get a secured personal loan, you’ll have to put personal property up as collateral. That means that if you can’t repay the loan, your property could be seized by the lender. If you don’t want to risk valuable personal assets, such as your car or home, you may instead want to apply for an unsecured personal loan or some form of business financing through your LLC or corporation. Obtaining business financing will protect your assets in a way that some personal loans may not.
So, is a personal loan a good way to fund your business? The answer is: It depends. It depends on your company’s financial situation, and your tolerance for personal risk. While we can’t provide you with a definite answer (after all, no one knows your business better than you!), what we can say is that the most important thing is that you do your research. When deciding how to obtain capital for your business, always weigh the pros and cons associated with each option. Think about what loan suits you personally, calculate what’s most affordable, and analyze which loan puts your business in the best position.
If you do your due diligence, you’ll get the funding you need—and, perhaps most importantly, set your company up for sustained growth and success.