3 rules for starting a business with a personal loan

“Only fools start businesses on loans.” That’s the advice of billionaire Mark Cuban, the rarely lost for words owner of the Dallas Mavericks.

While Cuban makes some good points in the interview, he also misses a few points in favor of starting a business with a loan. The 60-year-old Shark Tank star hasn’t had to raise money for his own business since he was in college buying a local bar.

Times have changed and interest rates are not what they were in the 1980s. Even iPhone giant Apple Inc, with $63 billion in cash on its books, owes another $93 billion in debt.

Not only is a business loan no longer dangerous, it could be the smartest financial move you make.

Why you might consider using a business startup loan

Cuban’s point is that people underestimate the hard work and time it takes to start a new business. He argues that most startups fail, which often means the owners are left personally responsible for the money, sometimes with the risk of bankruptcy.

That’s a valid point, but there’s another side to the story that he doesn’t mention.

Most new businesses fail due to lack of capital, inability to get the money to continue operating. More than three out of four businesses last up to five years before they run out of money because sales can’t keep up with costs.

So it turns out that getting a loan can actually keep you in business instead of bankrupting you.

Interest on business start-up loans

Business loans and other types of loans are some of the cheapest forms of debt in terms of interest rates. For example, interest rates on private business loans have fallen from over 25% in the 1980s to an average of 13.4% today, and loans approved by the Small Business Administration are even lower.

Even a personal loan with an average interest rate of around 14% is below the cost of using credit cards or equity financing to start a business. Equity financing, an ownership stake in a new company through a partnership or investors, requires a high expected rate of return. Investors won’t bet their money unless they think it will lead to high double or triple digit returns. Just ask Cuban and his fellow Sharks.

Business Loan vs Personal Loan

Once you understand the cost of different types of business financing, the question usually becomes either a business loan or a personal loan.

Business loans almost always offer a lower interest rate because business assets back the money. Lenders can seize or force you to sell business assets to make loan payments.

This is not the case with the unsecured personal loan. You won’t be forced to sell your home or other assets, and you can’t be pushed into bankruptcy with a personal loan. This peace of mind for the borrower comes with higher interest costs.

Business loans are usually for much higher amounts as well. For example, some business loan sites finance small business loans up to $300,000, while most personal loan websites will lend $40,000 with terms of three or five years.

There is probably no single answer as to what is the best loan for starting a business, but it may still be a redundant question. Most new businesses will not qualify for a business loan.

Minimum requirements for business loans

  • 12+ months in business
  • $50,000+ annual sales
  • No personal bankruptcies or tax liens

Business loans may also require personal collateral, so they won’t always protect you from losing your home or other personal property.

In comparison, personal loans are always unsecured and you can use the money for any purpose. Rates may be higher, but most people with a credit score of 600 or higher can qualify.

Using a personal loan to start a business

While using a personal loan to start a business can be a good financial decision, there are some things to remember before borrowing the money.

Start the business with as much money saved as possible, at least to the point of having a working business plan and approaching sales. Loan payments will start within a month, so you’ll need a way to start making them either through sales or by using the unused loan.

If business income isn’t growing fast enough, you’ll be forced to dip into savings or struggle to make payments.

Rule #1 for Startup Loans

Grow the business as much as possible with your own money and borrow only when sales are close.

I would also only recommend using a low capital business personal loan. The Internet ushered in the era of low-cost businesses, from Amazon FBA to a service website.

For example, it cost a minimum of $100,000 to start a retail business with manufacturing costs and a storefront. Now you can start one with just $5,000 through Amazon or Shopify. This means that a $10,000 personal loan can give you enough to get the business off the ground and have cash to spare to make payments as sales increase.

This will rule out many traditional types of businesses that still cost tens of thousands to start, but it is by far the safer way to start a business.

Startup Loan Rule #2

Use a startup loan only for low-capital types of businesses that can be started with $30,000 or less.

Finally, make sure you balance the early repayment of the loan with the cash needs of the business. It’s tempting to put all of your cash flow toward paying off the loan, but that could spell trouble if that cash flow dries up in a few months. In a dry spell, you don’t want to fall behind on payments, so maintain a cash reserve and plan for expected sales for the year.

Startup Loan Rule #3

Plan your expected cash needs for the year and maintain a cash reserve to make loan payments.

How to qualify for a business loan

Qualifying for a personal loan is easy and applying takes less than three minutes. You’ll need a minimum credit score and at least a part-time job to qualify on most websites, but that’s generally it.

Getting a business loan is more difficult and will take longer. Most business loans take at least two or three weeks to be approved and processed. This includes time to review financial statements and bank records.

Minimum business loan requirements are usually a year or more in business and current sales. Getting the best prices means higher sales in the $100,000+ area and repeat sales.

Despite the difficulty of getting a business loan versus a personal loan, you should still consider it as a source of funds. You will have access to more funds; even a 1% difference in interest rate can mean tens of thousands in savings.

Getting a loan to start a business is not the potentially negative decision it once was. There are good reasons to consider borrowing to finance your startup. Even multi-billion dollar businesses use debt financing and there are several advantages to using partnership or investor funds. Weigh the pros and cons and shop around for your business loan to make sure you’re getting the best rate.

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This article was created and syndicated by Wealth of Geeks.

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