Often, banks and other traditional lenders are wary to provide capital to small businesses that don’t have a financial track record unless adequate collateral is available. In fact, only
27.3 percent of small business loan applicants are approved by big banks, according to the Biz2Credit Small Business Lending Index™.
If you don’t qualify for a traditional loan product, you may find that a private business loan meets your needs. However, it’s important to understand exactly what private loans entail. In this post, we’ll explain what private business loans are, as well as their advantages and limitations. This should help you decide if they’re right for your business.
Everything You Need to Know about Private Business Loans:
Types of Private Business Loans:
A private business loan is a loan issued by a non-banking lender. The issuer can be anyone, including:
- A family member
- Friend
- Angel investor
- Venture capitalist
- Alternative lender
Private loans are often easier to qualify for than traditional loans but can also have less favorable terms, and in some cases higher interest rates.
There are several types of private financing available to small business owners, the most common of which include:
Typically, but not always, merchant cash advances and short-term loans are the most expensive options.
For example, a business that takes out a merchant cash advance can get access to funding almost immediately but typically pays back
20 to 40 percent more of the amount borrowed. They’re also the most accessible to small business owners.
On the other hand, private lines of credit and working capital loans often require you to submit collateral to secure the loan with your company’s assets, such as accounts receivable.
In many cases, it’s possible to borrow up to 90 percent of the value of your outstanding invoices. Of course, this type of loan requires you to have sales in the pipeline.
How to Qualify for a Private Business Loan:
Qualifying for a private business loan depends on the lender's specific requirements, but it’s usually easier than applying for a traditional business loan.
Private lenders like angel investors and venture capitalists, for example, tend to understand specific segments of the market better than traditional lenders. They make decisions based on your business’s potential, not its financial history. Therefore, you’ll likely need to provide a solid business plan and viable market before they’ll approve your financing application.
In comparison, alternative lenders typically have more relaxed qualification standards and therefore their loans are easier to obtain.
Most alternative lenders require a minimum credit score of 500 to 650, and a few have no minimum credit score requirement.
Private lenders will look at these aspects of your business, including:
- Your credit score
- Your annual revenues
- Time in business
- Previous bankruptcies
- Industry
- Preferred use of funds
- Outstanding debt
Finally, if you’re borrowing from a
family member or friend, a good-faith agreement may be enough to obtain funding. The IRS requires a formal contract, but the loan terms can be more favorable than working with other private lenders.
How to Obtain and Repay a Private Business Loan:
The private loan application process is typically much quicker to complete than applying for a traditional bank loan. This is because most alternative lenders require less documentation and minimal credit history. In many cases, you’ll be approved in a matter of days as opposed to weeks or months with a traditional loan.
Repayment plans for private business loans are outlined in the loan agreement. With a merchant cash advance, you’ll likely be required to remit a portion of your daily revenue until the loan is paid back. Private lines of credit or working capital loans may require accounts receivable financing, which means the lender is entitled to a portion of your outstanding sales. Term loans typically have more traditional repayment terms, requiring you to make payments on a weekly or monthly basis until the loan is paid in full.
Conclusion: Consider a Private Loan for Your Business
Although private loans are usually easier to obtain than traditional financing, their loan terms may not be the best fit for your business. That’s why it’s crucial to find a private business loan that has the right terms that fit your company's unique financial needs.
If you’re confident that you can repay the loan amount quickly, private loans can be a great way to finance your business. You'll have access to fast financing without the lengthy application process and stringent requirements of traditional lenders.
Before applying for any type of business financing, we suggest conducting thorough research so that you're aware of your options. Although you may require immediate funding, you shouldn't sign a contract until you're comfortable with the loan offer.
Have you received a private loan for your small business? Tell us about your experience securing this type of financing in the comment section on this page.
Editor’s Note: This post was updated for accuracy and comprehensiveness in November 2021.