It can be tough for individuals to gather the necessary funding to start a business. Or, for small businesses, to save enough to expand. This often means they need to look for sources of outside funding, like loans.
Luckily, there are multiple loan options out there that can be used for these purposes. This article will address two options: small business loans and personal loans.
Before you make a decision, there are major differences between small business loans and personal loans to be aware of. Read on to learn more about these two loans and their applications.
Credit Qualifications for Personal Loans and Small Business Loans
A major difference between personal loans and small business loans is the credit history required to get approved.
Personal loans are typically much easier to acquire than small business loans. That’s because they are based on personal credit history, which is relatively easy to build. People can also use prequalification to shop around for a personal loan that will best fit their needs.
Small business loans, on the other hand, can be challenging to get without an established credit history for the business. This makes it a much more difficult option for those just starting their business. Furthermore, the process can involve a lot of paperwork.
Can Personal Loans Be Used for Business?
As the name implies, people will typically take out personal loans for personal use. These may be used for debt management, home renovation, personal projects, and more. However, they can still be used for business purposes, but often more indirect types of needs.
Business owners should fully evaluate and strategize their need for a loan before proceeding.
Another factor to consider with a personal loan for business is the tax implications.
The particular state laws can vary, but most qualifying business expenses can be written off or deducted from taxes. While a business owner can often get a personal loan to fund business expenses, it will typically not be tax deductible. Of course, these taxes can add up for the borrower over time.
Small Business Loan and Personal Loan Interest Rates
Another notable difference between a small business loan and a personal loan is its interest rates.
Interest rates are one of the most important factors when deciding on a loan. It can be difficult for a loan to be beneficial if the payment regularly cuts into profits. There are common misconceptions that lead people to believe small business loans or personal loans may have lower interest rates. However, there is no concrete standard. Realistically, the interest rates for a loan will primarily depend on the following:
- The creditworthiness of a business or person
- The specific lender
- Repayment Terms
- Duration of the loan
- Rates available in the current market
The repayment terms can also differ greatly between these two loans. In many cases, small business loans may be able to be repaid at a slower rate or over a more extended period. This is also great for businesses looking for low payments because they want to reinvest more capital in their business.
In addition, they can be structured to have interest-only payments at the beginning of the loan term. This can make them great for startups or expansions that do not expect to have significant cash flow right away. This is also great for small businesses that want to reduce liability.
Loan Limits for Personal and Small Business Loans
In many cases, the lending limits for personal loans can be lower than those of small business loans. Expanding or upgrading a business can often require a significant amount of capital. In some cases, personal loan limits may not be enough to cover this. The loan limits on personal loans are typically between $1,000 – $50,000, which could be plenty for some smaller businesses. For others who are trying to fund significant expansion or growth, this could be too small of an amount.
Small business loans are a much better option for those seeking large loan amounts. Many lenders will offer loan amounts ranging from $5,000 – $500,000, with some even offering loans over $1 million. Some of the higher loans will likely require proof of adequate collateral for the lender. Lenders require this to even consider lending to a business.
Personal Liability
A factor that cannot be neglected is the personal liability tied to a loan. On a very basic level, personal liability is an individual’s obligation to repay a loan until the borrowed amount is fully repaid. The extent and requirements of personal liability will vary among different loan options. Of course, a personal loan will fully fall on the individual for repayment. On the other hand, some small business loans may have limited liability structures in place, such as an LLC. In this case, the debt will fall on the business. This can provide protection to the individual business owner(s) and their personal assets.
Secured Vs. Unsecured Debt
A secured loan is a loan that is backed by assets owned by the borrower, whether that is an individual or a business. The assets that secure the loan are considered “collateral”. In the event the individual or business stops making payments on the loan, known as “defaulting” on a loan, the lender can sell the borrower’s assets. This is an attempt to repay all or part of the remaining loan balance.
Unsecured debt, on the other hand, means that the loan is not backed by assets owned by the individual or business. The lender is not taking collateral for the loan. There is an expectation that the individual or business will pay back the loan based on the agreed-upon terms. The lender does not have a claim (called a “lien”) to the individual’s or business’s assets. The lender can still take measures to seek repayment on the loan. However, it is more difficult for them to pursue the individual’s or business’s assets.
Both personal and business loans can be secured or unsecured. Factors that determine whether a loan will be secured or unsecured include:
- The particular lender
- Loan amount
- Type of loan
- Creditworthiness of the business
Building Business Credit
It can be difficult to get approved for a small business loan, but it can prove beneficial to the business. Building the credit of the business is an important factor in helping expand later on. Strong business credit scores can lead to higher borrowing limits and credit options with financial institutions, vendors, and more.
There are many ways to improve your business credit score, which include:
- Making on-time payments
- Decreasing credit card spending
- Increasing your credit limit
- Paying off balances
Credit reporting agencies also consider the amount of credit used, versus the credit available. Keeping this ratio low will improve your business credit score.
Deciding Between a Personal Loan and Small Business Loan
As shown above, several factors need to be considered when choosing between a personal or small business loan. It is far from a one size fits all type of decision and business owners need to consider it carefully. There are primary questions and factors that a business can look over to decide, including,
Amount of Funds Required
An important first step for a business owner is to narrow down how much they will need for their goals. This can be a quick way to determine whether a personal loan will offer enough funding or whether they should seek a business loan.
Business Size
The first factor to consider is the current size of the business and what the intent for growth is. This will help to determine how much capital is needed to achieve the expansion desired. This will help root out whether a personal loan will be enough to cover the cost. If not, then a business loan may be the only real option.
Secured Vs Unsecured
Businesses with assets should consider whether a secured loan can even be an option. It can be intimidating to put up assets as collateral for a loan, but it can also be a benefit for the business.
For example, secured loans may give businesses access to higher funds and longer repayment terms. This can help a business stay up to date with payments while still having enough money to follow its plan.
Age of Business
As mentioned above, it can be harder for small businesses to secure business loans.
If the business has just started or has not had much success yet, for example, finding a lender to finance them might be difficult.
This is not to say that it is impossible, however. Businesses should consult with lenders to see whether it may be an option regardless of the business age.
Turned Down for a Small Business Loan?
Some businesses may have already tried to apply for a small business loan and were rejected. This can be discouraging, for sure, but business owners shouldn’t give up entirely. There are several other options that they should consider and look into before giving up on getting a loan.
A great option if you’re turned down to a conventional small business loan is an SBA loan. An SBA loan is a small business loan that is partially guaranteed by the U.S. government. They are typically administered by participating lenders like banks or other major financial institutions. For business owners whose needs aren’t met by traditional establishment banking, SBA loans are an excellent alternative.
Securing a Loan with Bad Credit
Unfortunately, bad credit does put a business or the owner in a tough spot for seeking a loan. Depending on how poor the credit is, some lenders may not even bother to look at the application. And although there are options for those with bad credit to try, they are not guaranteed to get a loan.
If you applied for a conventional loan, but were rejected immediately because of credit, SBA loans may be the best route. Because of their unique structure and government guarantees, they’re a great option for businesses with little or poor credit.
Other Options to Consider for Funding a Business
Business owners need to remember that loans are not the only option for funding a business. There are a couple of other options that businesses may even want to consider before looking into a loan. Grants are one such option.
We cover the difference between Grants v Loans as funding sources here. And if you’re looking for more information about Grants, check out our Abridged Guide to Grants here.
Another option for businesses to consider for funding is offering company equity. There are many investors out there that are looking for small business investments that offer equity in return. Even better, investors like this will want the company to succeed to grow their investment. As a result, they will offer financial support, resources, and possibly even guidance.
These arrangements can be excellent for both parties, as it helps the business expand and the investor gets a return. Of course, just like any other financial tool, the terms and conditions of the investment should be carefully reviewed before going forward.