The Pros and Cons of Startup Business Loans
Although there are benefits of receiving a startup business loan, most notably having money to get your business going, there also some downsides to consider.
Having business financing can help you grow your business, but you should also remember that your company is new. The first few months of running a business can be stressful, and it takes time to generate revenue. In addition, it takes time to determine what your business’s needs are.
As you can see, applying for startup business loans isn’t a decision that should be taken lightly. In this post, we’ll explain the pros and cons of startup business loans, so that you can weigh your options.
What Are the Pros of a Startup Business Loan?
1. You’ll Have Money to Start Your Business
Starting a business requires enough working capital to afford initial expenses, such as inventory, real estate, equipment, payroll, and other necessary costs. Depending on your business’s industry, you may need more funds 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. That way, you can make sure that you’re putting your best foot forward as you start this new venture.
2. You Can Retain Ownership
A startup business loan may be an alternative to seeking investor financing, who may ask for a share of equity in your company. By funding your venture with a traditional loan, you’ll have more leeway when considering potential partnerships. For example, you’ll have the option to choose investors based on strategy, rather than monetary value.
Also, it’s important to note that investors may have the power to make other decisions that directly affect your business. If you feel strongly about maintaining control over your business, applying for a startup loan may be a better option.
3. You Can Protect Personal Wealth
A startup business loan can help separate your personal wealth from your business’s finances. Every new enterprise comes with risk; the most well-planned venture may face obstacles that are out of your control as the business owner. Therefore, you should think twice about pledging personal wealth such as the equity on your home, retirement savings, or money needed to live.
Ultimately, procuring a startup loan can allow you to open your business, without putting your own finances at risk to do so.
4. You Can Build Business Credit
Eventually, your business may require a large cash infusion to continue growing. When it does, it’s beneficial to have a history of responsible credit use to show your lender. 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 amount 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.
What Are the Cons of Business Loans for Startups?
1. They Can Be Hard to Qualify For
From a lender’s perspective, startup loans are a risky venture. New companies fall short in all of the metrics banks use to determine loan eligibility, which include:
- Financial records
- Credit history
- 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.
2. These Loans Can Restrict Cash Flow
Loans typically require monthly 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.
Before applying, review your business plan and consider your business’s consistent expenses. For example, if you’re already paying for rent, utilities, and inventory, and your cash flow is considerably low, it might be too challenging to also make loan payments.
3. 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 they funds already have.
Startup history is littered with stories of expensive failures. When it comes to building new businesses, deep pockets don’t guarantee success, sometimes even hampering it.
4. Your Personal Credit Might Be Put at Risk
A business loan won’t guarantee that your personal finances are protected. Given the extra risk of lending to small businesses, many financial institutions require a personal guarantee, which means banks can come after you for repayment if the business defaults. Therefore, your personal credit score and assets may be impacted.
If you’re concerned about how your personal credit could be affected, we suggest waiting a few months until your business is more established. That way, you’ll be able to repay your loan on time, while ensuring your personal credit remains in-tact.
5. You Won’t Know How to Best Utilize the Loan Yet
When experienced business owners receive a loan, they’ve had ample time to understand their operations and know how the loan can benefit them. In comparison, as a new business owner, you’re probably still identifying the ebbs and flows of your company.
Currently, you’re simply trying to attract new customers and ensure that you can afford necessary expenses. However, in a few months you might decide that you want to invest in a certain type of inventory that’s selling out or that you need to hire more employees.
By waiting a few months to apply for a business loan, you can make sure that you’re using the financing for the right areas.
6. You Might Not Even Qualify!
Many alternative and online lenders won’t supply financing to startups. Other loan providers have a time in business requirement and won’t provide loans to businesses that haven’t been operational for a certain length of time.
Before taking the time to apply, conduct research or contact lenders directly to find out if they provide financing to new businesses. By doing this, you won’t waste your time applying or compiling financial information, only to be declined due to your short time in business.
Conclusion: Consider All Aspects of Startup Business Loans Before Applying
There are pros and cons to pursuing a startup loan, such as issues with ownership, eligibility, risk to personal credit, and the cost of repayment. However, qualifying for a small business startup loan could mean having money to start a company unattached to loved ones expecting repayment, or investors who will want ownership in exchange for their investment. Small business owners should weigh all considerations before deciding to move forward with this loan option.
Have you pursued business financing as a new entrepreneur? Or did you wait until you had an established business before applying for additional funding? Tell us about your experience with startup business loans in the comment section below!
Editor’s Note: This post was updated for accuracy and comprehensiveness in January 2021.
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.