Anyone who’s ever tried to start or operate a small business knows one of the biggest priorities any company needs is cash. Your business will need to cover the hard costs of your goods or services, employee wages, office space, marketing — the list goes on. These costs are a part of doing business but are even more acute for small businesses, especially those with narrow margins or that aren’t yet earning a profit. All of these expenses are why many business owners use loans to fund their companies, sometimes resorting to personal loans to cover business costs. While that can help you access the capital you need, this strategy does involve some risk.
Here’s what you should know about using a personal loan for a small business.
Can you use a personal loan for your small business?
Technically, yes, you can use a personal loan for your small business. When the funds from a private loan are dispersed to you, they’re typically available for whatever personal expenses you decide to allocate them toward, which could include personal business projects. However, because you can doesn’t mean you should. You should keep the risks of using a personal loan for your business in mind. Here are the pros and cons to consider.
- It could be hard to qualify for a business loan, especially if you’re just starting out or have a high-risk venture. You might get a loan faster and easier if it’s a personal loan, which could be tempting to some business owners.
- Many personal loans are unsecured, which would require putting up no collateral. Some new businesses have no collateral to offer, which makes it hard for them to qualify for business loans.
- You might qualify for a lower interest rate with your personal credit. That said, if your business is getting quoted very high interest rates, make sure you understand why. If it’s because lenders don’t like the look of your cash flow, that could spell trouble when it comes time for the business to help you repay your personal loan. Someone with excellent credit can expect an interest rate of 10.3%-12.5% for a personal loan.
- You can receive loans for small amounts. Banks tend to prefer lending businesses larger sums of money because they stand to earn more in interest. If you only need a small sum, qualifying for a personal loan might be a better fit.
- You’ll be personally liable for repaying the funds of the loan. If the business fails, you’ll still have to repay the loan to save your personal credit.
- Depending on how big the loan is, it could prevent you from accessing other funds in the future for personal purchases such as a house or an auto loan. Lenders look at your debt to income ratio when determining if you qualify for more credit. Taking out a large personal loan that you’re using for your business could skew this ratio.
- Consolidating business and personal expenses can make your financial situation confusing when filing your tax returns.
- A personal loan does not help your business establish a relationship with a lender that could be valuable if more credit is needed in the future.
- Mixing personal finances with your business could increase your personal liability if your company is sued for any reason.
- If your business has several debtors, tying up your personal funds in the business could impact larger business decisions about how to prioritize your debts. Will the business pay you back first or others?
Despite the risks of using a personal loan for business, some business owners still decide the pros outweigh the cons. If you decide to take this route, make sure to formalize an agreement for how the business will repay the funds to you. For example, you could make a shareholder’s loan to the business with the funds you receive from the personal loan. Should your business sell before the funds are repaid, you can include a clause that stipulates the buyer is responsible for settling the business debt on the books prior to the sale or out of the proceeds of the sale.
Alternatives to getting a loan
Not all businesses use loans when they need more cash. Even if you were denied a business loan, you don’t necessarily need to resort to using a personal loan to help your business. Here are some alternatives.
1. Earn more money to bootstrap: If you’re just starting a business and need some extra cash to help with start-up expenses, you could consider smaller, simple business activities to earn cash that will go toward your business. Looking for ideas? Can you leverage your skills as a founder to earn money for your business? If you’re good at search engine optimization, for example, is there a way to make that part of your business offering to bring in cash until the rest of your business is running? Look for strategies like this that can help you bring in extra cash to get started.
2. Improve your business processes: If you’re looking for extra cash to scale, start considering the areas where your operations are not as tight as they could be. For example, recent data from a case study shows e-commerce companies were able to recover 58% in lost revenue from abandoned carts by simply sending automatic text messages. This low investment, high reward solution netted one company in the study an extra $156,915 in revenue over 30 days. Extra revenue like that can then be applied to growth. And as a bonus, you don’t pay any interest on it.
3. Find a small business grant: Local, state and even federal organizations that want to support small businesses will sometimes offer startup or development grants to help cover some of the costs of doing business. Unlike loans, you don’t have to repay grants. While it could take some research to find a grant that is a good fit for you and your business, qualifying for funds in this way can be a huge boost to the growth of your company. You can start your search through the U.S. Small Business Administration, which offers federal grants and tools for finding additional grant money.
Which strategy is right for you?
Whether you decide to use a personal loan for business funds, work with a lender to qualify for a small business loan or pursue an alternative option, remember that each scenario has its pros and cons. Deciding on the right strategy for you often comes down to how much personal risk you’re willing to tolerate and where your skills are as a business owner. Carefully consider each option and consult with business mentors before making your choice.