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All businesses require financing. However, owners have two general options to consider. They can choose a personal loan or a business loan. Both make sense but in different scenarios. Here, we take a look at when each is appropriate.
Choosing a Personal Loan
Seeking a personal loan for business purposes is counterintuitive. After all, the money isn't for you; it's for the company. Why put your finances and credit history on the line when the cash is going elsewhere? The answer is timing.
A personal loan is most appropriate for your business in its early days. Why? Because in the beginning there is little or no history to illustrate your viability as a business. Banks want to see records of free cash flow, goodwill, and profitability. A new business will not have any of those things.
The owner, however, does have a credit history. Banks will be more willing to loan money to a responsible consumer rather than an unproven business. In fact, many banks will not even look at companies that are less than two years old. For example, the Small Business Administration (SBA) reported that in 2016 only 10% of their loans issued went to companies valued at $150,000 or less. Even companies with valuations ranging from $150,000 to $350,000 made up just 11% of loans. Being the little guys is a disadvantage when seeking a business loan. However, it's an advantage when going the personal loan route.
If you have a strong credit history, you'll likely qualify for a loan at an affordable rate. Again, banks shy away from smaller businesses because the loan request is often too small. Lower lending requires the same amount of processing work for a bank without the profitability of a big loan.
A personal loan also solves the collateral problem. New businesses have little or no collateral. Even if you do have physical assets to pledge you may not be comfortable with risking them for a loan. A personal loan, in most cases, fixes this issue. Most personal loans will not require you to post collateral.
Choosing a Business Loan
Now your business is on its way. You have a few years under your belt and some history of profitability. With strong positive cash flow, you'll be able to show the bank why you're a suitable candidate for a traditional business loan. Additionally, you’ll likely have built up the hard assets needed when a bank requests collateral. At the same time, you’ll have a substantial list of accounts receivable to point to when banks ask questions about your viability. Finally, past financial returns will further illustrate your strength.
A business loan is particularly useful for those with only a short-term need, for example, three to 18 months. Capital is often required to take the next step in growing the operations. Or, it’s a solution for bridging a seasonal gap in revenue. Business loans can be appropriate for larger amounts, however, there will be more paperwork and due diligence required. If fast processing is critical a smaller loan may be your only choice.
With a smaller loan, you can get through the paperwork fast as banks can move quickly. The sooner you get the cash, the faster you can return your focus to where it's needed: the business. Some small business loans are available for companies with annual revenues as low as $50,000. When annual revenues climb to $100,000 some companies will offer as much as $500,000.
If you’ll need more time to repay, or a larger sum, a business loan might still make sense with help from the SBA. In this case, the paperwork will be lengthy, and the cash will not come fast. However, the maximum amount is $5 million, and there is no minimum loan request. The average SBA loan total in 2015 was $371,628. Also, repayment terms are flexible (5-25 years).
Think of a business loan as financing 2.0. You've already used a personal loan to get things off the ground. Now you're more established, and you want to build credit for the future, purchase better equipment, or increase inventory to fulfill more demand. Now that you’ve proven yourself as a skilled business owner you can also benefit from lower rates that often come with a stronger balance sheet. The idea isn't just to get the loan but to earn one at the lowest possible expense. There's no better way to do this than drive down the rate. As a low-risk applicant, you'll be in a better bargaining position to command more affordable financing.
Some business owners can get the best of both worlds with an online business loan. Many online lenders offer the speed that would otherwise only be available with a personal loan. The list of requirements is often shorter than what you’ll see at a traditional bank and technology makes credit analysis faster.
This solution is also cheaper as research suggests peer-to-peer lenders can operate at costs 60% below brick-and-mortar banks. It’s no wonder the head of the British Business Bank remarked that marketplace lending is “starting to make an impact.”
Remember, at all stages of business you’re likely to require financing therefore keep costs in mind, like your business they’ll be a going concern.
The article Funding Your Business With a Personal Loan or Business Loan originally appeared on ValuePenguin.