March 16, 2022
The Top 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 up and running, there are also some downsides to consider. Having a loan for your new business can help you grow your venture, but you should also remember that your company is inexperienced. 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 short term and long-term funding needs will be. As you can see, applying for startup business loans isn’t a decision that should be taken lightly. In this blog post, we’ll explain the pros and cons of startup business loans, so that you can carefully weigh your options.
What Are the Pros of Business Loans for Startups?
1. You’ll Have Money to Start Your BusinessStarting a business requires enough working capital to afford initial expenses, such as:
- Real estate
- Hiring expenses
- Marketing costs
- Necessary technology
2. You Can Retain Business OwnershipA 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 funding option.
3. You Can Protect Personal WealthA startup business loan can help separate your personal wealth from your business’s finances. Starting a new enterprise involves 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 home equity, 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 CreditEventually, your business may require a large cash infusion to afford inventory, expand your operations, or afford marketing costs. When you pursue financing, 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 lowers investment risk for the lender. However, if you have poor credit, you’ll find it challenging to qualify for funding with good terms. 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 Startup Funding?
1. They Can Be Hard to Qualify ForFrom a business lender’s perspective, startup loans are a risky venture. New companies fall short of all the metrics banks use to determine loan eligibility, which include:
- Financial records
- Credit history
- Proof of business longevity
2. Startup Loans Can Restrict Cash FlowTerm 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 making regular loan payments will factor into their budding organization’s finances. Having monthly payment obligations could restrict cash flow to run or grow the business. Before applying for a startup loan, review your business plan and consider your business’s consistent expenses. For example, if you’re already paying for utilities, rent, and inventory, it might be too challenging to also make loan payments. In addition, it will be even more challenging if your cash flow is limited, and you aren't earning significant sales yet.
3. Less Need for BootstrappingLimited working 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 the startup funds they 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. So, before you take out a business loan, make sure that the funds are necessary and won't hinder you in the future.
4. Your Personal Credit Score Might Be Put at RiskA small 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 intact.
5. You Won’t Know How to Best Utilize the Loan YetWhen 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 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 or line of credit, 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 compiling financial information and applying, only to be declined due to your brief time in business.
Next Steps: Seeking a Startup Business LoanAfter reading this list of pros and cons, hopefully you're able to determine if you think pursuing startup funding is right for you. If you want to pursue startup business loans, we suggest researching popular funding options next:
- Small Business Loans from Alternative Lenders
- Business Lines of Credit
- SBA Microloans
- SBA 7(a) Loans
- Business Credit Cards
- Merchant Cash Advances
- Equipment Loans
- Inventory Loans