Finding small business financing can be a tricky, counterintuitive process. It’s almost always easier to qualify for a business loan when you have a solid history of success in business. But what about when you need financing in order to get your business off the ground?
When a business loan is difficult to obtain, it’s natural to consider taking out a personal loan and using those funds as capital for your business. And while you can do this, the question is should you do this?
Read on for everything you need to know before considering this route.
How personal loans for business work
In most cases, a small business owner should consider traditional or alternative business financing when they need capital to grow their business. But there are many reasons business financing may not work out, and in those cases, some small business owners take out a personal loan against their own finances to fund their business needs.
Since personal loans are indeed personal, how you use the capital you receive from the loan is pretty much up to you. Business lenders want to see a solid plan and knowledge of the industry you’re in before approving your financing, but personal lenders simply need to feel sure that you’ll pay the financing back. The ability to qualify for a personal loan will depend heavily on your personal finances and credit history. A good credit score can prove you have a solid history of making your credit payments on time and of paying back the debts you owe.
The downside here is that, if you don’t have a good credit score, you may be out of luck when it comes to using a personal loan to finance your business.
Who qualifies for a personal loan for business?
As stated earlier, having a good credit score is one of the biggest factors when it comes to being approved for a personal loan for business. In fact, no information about your business will come into play during your personal loan application process. If your personal credit score is above 580, a personal loan for business could be a viable option. But the higher your score, the better your chances are of qualifying.
When it comes to your personal loan application, the process is pretty simple. In addition to checking your credit, potential lenders will need to see things like:
- Bank statements
- W-2 and/or pay stubs
- Tax return
- Personal identification
When a personal loan for business makes sense
The bottom line is that when looking for business financing, the majority of small business owners should first consider business financing. That is, after all, what it’s made for -- to increase capital for your business. But there are a few scenarios where you may want to consider a personal loan for business.
First, how long have you been in business? If you don’t have established business history, a personal loan could mean the difference between getting some financing or none at all. Since personal loans can be used for essentially any purpose, using your personal loan to finance your business would function similar to investing in your business with your own capital.
If you only need a small amount of capital, a personal loan may also work for you. Banks are hesitant to give out business loans in small amounts, and though alternative business lenders sometimes offer smaller loans, they usually come with higher interest rates. A personal loan can be a good way to get a little extra money with more manageable interest rates and payment plans.
One of the most common reasons banks deny business loans is insufficient collateral. Though alternative lenders or SBA generally won’t deny you solely based on lack of collateral, a small personal loan is unlikely to require collateral. However, a larger one might.
When to use business financing
If you’ve been in business for a while, are profitable and you have a specific need for your business, it likely makes sense to pursue business financing first.
For example, let’s say you’re an established business with a great track record and find yourself in need of extra capital for a specific business need. Whether you need inventory financing or a way to cover invoices, a business loan may be a better route than a personal loan. You won’t find a personal loan that covers a business-related need so specifically.
Also, if you need a substantial amount of money -- generally more than $50,000 -- a personal loan may not cover your business needs and business financing may be a better way to reach your financial goals.
Finally, if you think you may qualify for an SBA loan, and you have the patience and diligence to follow through with the lengthy application process, it’s definitely a good idea to pursue this before a personal loan. Because they’re low-cost, carry generous repayment terms and are backed by the U.S. government, these loans are incredibly desirable -- and worth the effort if you qualify.
When it comes to business financing, a lender will consider your time in business and future potential, your credit history and your company’s financials. If you qualify for business financing, it’s often the better route to fund your business. But if you’re just getting started, a personal loan can be a valuable tool for covering your business’s needs.
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This article originally appeared on Entrepreneur.com. Minor edits have been done by the Entrepreneur.com.ph editors.