Should I Take Out a Personal Loan to Fund My Small Business?
Compared to most business loans, personal loans are easier to qualify for, require less documentation, and usually come with a faster funding process. However, they can also hurt your personal credit and only provide a limited amount of money. Plus, they won’t help you build your business credit score, which is an important factor to consider.
All this to say, there’s no rule that says you should or shouldn’t take out a personal loan to fund your business. Sometimes it makes sense for your business to pursue a personal loan, sometimes it doesn’t. It’s up to you to decide how to invest in your business.
In this post, we’ll outline the benefits and drawbacks of using a personal loan for business. Then, we’ll wrap up with a discussion of how you should think about these benefits and drawbacks in the context of your business.
The Advantages of Using a Personal Loan for Business
1. Lenient Eligibility Criteria
At a minimum, traditional business loans often require evidence of multiple years of profitable performance. That means if you’re starting a new business, traditional loans are hard to qualify for. Personal loans have a distinct advantage here because they don’t require a long, successful business history.
In fact, even brand new small business owners can obtain a personal loan, as long as their credit score is at least 610. Therefore, unless you have significant assets or existing relationships, traditional loans aren’t usually an option for new entrepreneurs. However, if you’d like to improve your business credit score, taking out a personal loan won’t help. Pursuing a personal loan won’t affect your credit score, because it isn’t a business loan.
It can be similarly difficult to obtain a traditional loan, even if you’re experienced, if your business hasn’t performed exceedingly well. With personal loans, though, the lender only looks at your personal financial health. So even if your business is struggling, personal loans remain a viable option.
2. Quicker, Easier Loan Application Process
Business loans require extensive documentation including, but not limited to, documents like:
- Income statements
- Balance sheets
- Cash flow statements
- Business bank account statements and tax returns
- Business licenses and proof of ownership
By contrast, personal lenders don’t need to see these kinds of financial and business documents. Therefore, it can be easier to get a personal loan approval.
All personal lenders need is a credit report and documentation to verify your identity, income, and address. This makes the application process for personal loans much faster and less labor-intensive for you.
3. Fast Access to Lump Sum Financing
“Small business loans don’t always provide a lump sum. Instead, you might have to submit a draw request to have the loan proceeds disbursed to you periodically. To do that, you may have to show invoices, receipts or a project budget documenting what the money will be used for. With a personal loan, you would be able to receive access to the lump sum.”
If you’re short on time and need cash fast, the speed of funding a personal loan is a major advantage. This is especially the case if you have an urgent funding need, and need financing to:
- Consolidate debt
- Fix broken equipment
- Meet an urgent payroll deadline
- Have additional cash flow during an unforeseen emergency
The Drawbacks of Using a Personal Loan for Business
1. Personal Loans Don’t Count Towards Business Credit History
When you take out a business loan, you build up your business credit history.
However, with personal loans, your payments aren’t reported to any of the business credit bureaus. That means, even if you make all your payments on time and in full, your business credit score won’t improve.
Of course, by making timely payments, you could use a personal loan to improve your personal credit score. Although that won’t help make your business loan application more attractive to an online lender, it also won’t hurt.
Before taking out a personal loan for your business, you should fully understand the repayment terms. Although you should be confident that you can meet payment deadlines on-time, it’s important to be aware of any prepayment penalties.
2. Maximum Loan Amounts are Limited
Since personal loans are designed for consumers, they’re significantly smaller than business loans. For example, an SBA 7(a) loan maxes out at $5 million, personal loans are usually capped at around $50,000.
If you’re looking to fund a new business, the lower limits of personal loans may not be an issue. For larger businesses, though, low loan limits are often a non-starter.
Ultimately, every lender is different and will have different loan amounts, terms, and conditions. The offers will vary based on the lenders
3. Personal Loans Increase Your Personal Financial Liability
When you take out a personal loan, even if you use it for your business, you’re personally liable for the debt. That means, if you default on an unsecured personal loan, the lender has the legal right to sue you and ask the court for compensation. If successful, the lender may be able to place a lien on your house or garnish your wages.
If your loan is secured by collateral and you default, the lender can seize your collateral.
All that said, while business loans don’t always require a personal guarantee, they often do. When a personal guarantee is required, you’re also personally liable, even if it’s a business loan.
Conclusion: Understand How Personal Loans Can Affect Your Business
Success in business is about exploiting your company’s current strategic position. Using a personal loan, or any other type of financing, to fund your business is similar. The key to success is to find the financing that fits your business needs and supports your strategic plan.
Ideally, your choice of business financing will help you better exploit your strengths or shore up weaknesses in the marketplace.
If you’re not sure if personal loans are right for your business, read about these other financing options:
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.