Should Personal Loans be Used to Start a Small Business?
It is not always easy to find the money to launch a new business. Traditional business loans are normally not an option for a fledgling business; lenders prefer to make loans to companies with established records of sales and expenses. However, insufficient funding is one of the leading reasons that new businesses fail. Caught between the proverbial rock and a hard place, many entrepreneurs wonder whether personal loans can and should be used to start a new business.
Should Personal Loans Be Used to Launch a New Business?
It is possible to use personal loans to cover some of the costs related to starting a business. Whether it is a good idea to do so, however, must be evaluated on a case-by-case basis. While there are advantages to using personal loans to finance a new business, borrowers should also evaluate the potential risks and disadvantages.
The Benefits of Using Personal Loans for Business Expenses
The Indiana Small Business Development Center lists two important benefits of using personal debt to start a new business.
• Availability: After the financial meltdown of 2008, traditional lenders tightened their requirements for business loans. Many banks will not make a loan unless the company has been in business for at least three years and can provide financial statements proving profitability. Even then, the lender may require that the company have tangible assets that can be used as collateral for the loan. However, personal loans online or through local storefronts are widely available and seldom require collateral.
• Speed: Many conventional business loans require a lengthy underwriting process and/or multiple levels of approval. The entire process can be time-consuming as well as stressful. Personal loans online are usually processed no later than the next business day. Decisions on many bad credit personal loans can be made on the same day that the application is received.
The Disadvantages of Using Personal Debt to Finance a New Business
In an article published by The Huffington Post, the author points out that there are some disadvantages to using personal credit to cover business expenses.
• Personal loans online tend to be for relatively small amounts. Because bankers must typically follow the same underwriting procedures for every loan, their costs for initiating the loans are substantially the same for a $1,000 loan as for a $100,000 loan. Therefore, they prefer to make larger loans so that they will earn the most interest over the life of the loan. Bad credit personal loans and similar products do not have the same underwriting procedures as banks. This increases the risk that a borrower might default, so lenders have definite caps on loan amounts.
• Intermingling personal and business financials can make it more difficult to track progress in both areas. Keeping the record straight will require a little extra bookkeeping. For example, the money going into the business should be attributed properly; most businesses show the money in an account labeled as contributed capital or owner investment.
In addition, personal loans carry personal risks. The lender is making the loan to an individual rather than a company. Even if the business fails, the borrower must still repay the loan, and if the loan is secured by the borrower’s personal assets, these assets could be seized if the borrower fails to repay the loan.
Many sources of personal credit, including bad credit personal loans, have a high annual percentage rate, especially if origination fees are included in the annualized rate. Many personal loans online also have relatively short terms, often as little as three months. Although it may be possible to refinance these types of loans, rolling them over can prove costly.
Best Choices for Using Personal Loans to Start a Business
Personal loans can be a viable method of obtaining capital for a new business when the amount of money needed is relatively small. For example, if launching the business requires investing in a new printer or a piece of specialized equipment, lenders offering personal loans online can be good sources of funds. A business license or other one-time expense might also be a valid reason to access your personal credit. Bad credit personal loans can help those with impaired credit secure the funds for a higher down payment on a piece of needed equipment.
Potential Pitfalls to Avoid When Using Personal Loans to Start a Business
When using personal credit to finance a business, borrowers should attempt to mitigate their risks.
• Never borrow more than is needed, but never borrow if the loan will not be sufficient. If the equipment needed costs $5,000, a loan for $500 is not going to serve any useful purpose.
• Have a realistic plan to repay the loan. People who still have a full-time job or who have personal savings will typically have an easier time paying off the loan. Those who have no source of income other than their fledgling business or who have no financial safety net should not rely on their business earnings to cover the payments.
• Shop around to find the best deal on a loan. Lenders who offer bad credit personal loans and personal loans online charge different interest rates as well as different fees.
• Avoid using personal assets as collateral for a loan. Stay away from lenders who want to secure a personal loan with the title to the family car. Avoid home equity loans as well. Although both of these types of loans have their place in a sound financial strategy, the risks are too great to enter into these loans to invest in a business that has yet to earn a profit.
• Consider all available options before making a decision. Family members or friends could provide loans, but it is critical to formalize the repayment agreement to avoid hurt feelings or damaged relationships. Alternatively, former colleagues, relatives or friends might be willing to invest in the business in return for a share of the future profits. Personal credit cards can be used for purchasing equipment or other expenses; although the interest rate may be high, monthly payments may be more affordable.
• Investigate alternative loans that are related to specific demographics. For example, veterans and members of the military as well as their spouses may qualify for special loans from the Small Business Administration. Some municipalities offer loans to those starting a business in a specific neighborhood. There are also loans and grants for women, members of minority groups and certain disabled individuals.
• As a final option, consider putting plans on hold to build up a savings account. Starting a business can be stressful. Having to worry about how to pay off debts can rob an entrepreneur of energy, creativity and peace of mind. The business as well as personal relationships could suffer, so if it is possible to avoid debt, it might be better to delay.
Starting a business can be complicated. The decision on whether to use personal loans to fund a new business must be an individual decision. However, learning about your options can help you create a realistic plan. You can learn more about personal loans at the Personal Money Store.