Pros and Cons of Startup Business Loans
In this post, we’ll explain the pros and cons of startup business loans, so that you can weigh your options.
Pros of Pursuing a Startup Business Loan
Money to Start Business
Starting a business requires enough capital to afford upfront expenses. Depending on your business’s industry, you may need more than you can borrow from savings, family, or credit cards to get off the ground. If your business requires a large initial investment, such as inventory or equipment, a startup loan may be one way to get needed funds.
A startup business loan may be an alternative to seeking investors, who may ask for a share of equity in your company. By funding their venture with a loan, entrepreneurs have more leeway when considering potential partnerships. For example, they have the option to choose investors based more on strategy, rather than monetary value.
Protect Personal Wealth
A startup business loan can help separate the owner’s finances from their business. Every new enterprise comes with risk. The most well planned venture may face obstacles out of the founder’s control. Entrepreneurs should therefore think twice about pledging personal wealth such as the equity on their home, retirement savings, or money they need to live.
Building Business Credit
Your business may eventually need a large cash infusion in order to keep growing. When it does, it helps to have a history of responsible credit use. As with personal loans, having a strong credit history indicates reliability as a borrower, and lower investment risk for the lender. By taking out and paying back a smaller loan first, owners increase the chance of their business being approved for a bigger loan in the future. It may also help secure lower interest rates.
Hard to Qualify
From a lender’s perspective, startup loans are a risky venture. New companies fall short in all the metrics banks use to determine loan eligibility: revenue, financial records, credit history, or proof of business longevity. The difficulty of obtaining a startup business loan is perhaps it’s biggest caveat. This is especially true when the applicant lacks strong personal credit, assets for collateral, and large down payments.
Restricts Cash Flow
Loans typically need to be serviced monthly with payments for some combination of interest and principal. Missing loan payments can mean irreparable damage to business and personal credit. Small business owners should consider how regular loan payments factor into their budding organization’s finances. Having monthly payment obligations could restrict cash flow to run or grow the business.
Less Need for Bootstrapping
Limited capital can be a powerful motivator. Well-funded entrepreneurs may be tempted to throw money at issues, whereas lack of funds might force them to be more creative in stretching what funds they do have. Startup history is littered with stories of expensive failures. When it comes to building new businesses, deep pockets do not guarantee success and may sometimes even hamper it.
Risking Personal Credit
A business loan is no guarantee that personal finances are protected. Given the extra risk of lending to small businesses, many financial institutions may require a personal guarantee, which means banks can come after you for repayment if the business defaults. This means that even your personal credit score and assets may be impacted.
There are pros and cons to pursuing a startup loan, including issues concerning ownership, eligibility, risk to personal credit, and the cost of repayment. However, qualifying for a startup loan could mean money to start a business unattached to family and friends, who may expect repayment, or investors, who may want ownership for their investment. Small business owners should weigh all considerations before deciding to move forward with a startup loan.
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.