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The right small business financing for your company can come in so many forms, and from so many sources: There’s debt vs. equity, term loans vs. lines of credit, secured vs. unsecured loans, bank loans vs. alternative lenders vs. private equity vs. crowdfunding… At a certain point, you might call the whole search off, and opt for a simple, straightforward personal loan instead. But can you use a personal loan for business, really? When does it make more sense to apply for a business loan vs. personal loan?
We can tell you right off the bat that, yes, it’s possible to secure a personal loan for your business. But a personal loan for business use might or might not actually be a good idea, depending on your circumstances.
For a more involved answer, we’ll give you a clearer definition of business loans vs. personal loans, then we’ll run through a few common scenarios businesses find themselves in when they’re seeking financing. Once you take stock of your business’s finances, your personal finances, and your reasons for funding, you can figure out whether personal loan is a good idea for your business—or if you’re better off buckling down into the search and pursuing a business small business loan.
On the surface, business loans and personal loans look pretty similar. They’re often structured in similar ways, for one thing—usually, they’re either a renewable line of credit (think credit cards), or a lump sum that you repay with fees and interest. (Business loans pose some exceptions to this paradigm, which we’ll get into later.) And you can obtain either a business loan or a personal loan from a variety of sources, including banks, online lenders, and credit unions.
Obviously, though, there are some crucial differences between these loans. (If there weren’t, they wouldn’t have different names, right?) Here are the major distinguishing features of both business loans and personal loans, which should start to give you an idea of why, and when, one loan is better suited for certain businesses than the other.
Put simply, business loans are intended strictly for the purpose of financing a business. But those use cases can take many forms—covering payroll, opening a second location, renovating an existing location, restocking inventory, freeing up cash locked into unpaid invoices… whatever it takes to keep your business thriving.
Business loans allow you to use your company’s financial reputation, including credit and cash flow history, to earn approval. And because business loan amounts tend to be significantly higher than personal loan amounts, they’re riskier for lenders—so lenders only feel comfortable extending loans to the businesses they deem not risky. For the most part, that translates into business owners with high personal credit scores, whose companies have good business credit scores and a proven track record of profitability.
Business loan applications can include lots of paperwork, and lenders use all those documents to determine risk—aka whether or not they want to extend you financing, as well as the rates and terms of an approved borrower’s loan. Some factors lenders consider during the underwriting process include:
Because lender requirements can be demanding, some businesses, especially newer ventures, might have a hard time securing these loans. Additionally, business loans often come with strict terms concerning how the money can be used, and you’ll likely be asked to offer up collateral to mitigate the lender’s risk of losing everything in case of default.
The bottom line on business loans:
In contrast to business loans, which are given to businesses solely for the purpose of business financing, lenders extend personal loans to individuals. As you can imagine, personal loans are meant to finance personal matters, like your home, car, education, medical expenses—or, in certain scenarios, to start or augment a small business.
If you apply for a personal loan, your lender will evaluate your personal income and credit score to determine whether you’re eligible for a loan and, if so, your loan’s rates and terms. Your personal credit score is extremely important in this scenario—if it’s on the lower end of the scale, you’ll have a tough time qualifying for a personal loan. (If you secure your personal loan from a friend or family member, though, it’s pretty unlikely that they’ll care about your credit score or income.)
Typically, personal loans allow more flexibility in how you apply the funds, and many don’t ask for collateral to secure. They also often have lower interest rates than business loans do.
Also be aware that, in each loan scenario, the lender holds a different party responsible for the debt. In the event of default on a business loan, the lender has the right to go after the business’s assets to recoup the debt. But in the event of default on a personal loan, the lender can sue the individual to collect what they’re owed.
The bottom line on personal loans:
So, when is a personal loan your best option? And when is it better to wait for your business to grow enough to qualify for a good small business loan? Consider these scenarios to learn if a personal loan is the right match for your business.
The vast majority of the time, you should seek a small business loan, not a personal loan, if you need to finance your business. (That’s what business loans are made for, after all.) If your business meets these criteria, applying for a small business loan is a no-brainer.
Consider this scenario: Your business is already up and running, you’re backed by excellent credit and assets, and you’ve got a plan for your funds that makes the bank confident in your mutual success. Sound like you? It might be time to forge ahead with a traditional business loan from your bank, or a different business loan product from an online lender at favorable terms.
Business bank loans are so desirable for a number of reasons, not the least of which is that approved borrowers can receive high loan amounts at very low interest rates, and payments are usually due on a predictable, monthly schedule. But bank loans are a competitive space, and banks are in the privileged position of picking and choosing which borrowers they want to work with. As a result, many small business owners are deemed ineligible for bank loans, so they’ll turn to alternative financing, instead.
Although business loans from online lenders are generally easier to qualify for than their bank-issued counterparts—and, if approved, you might have access to your funds within a single day—they’ll usually carry terms that are a little more demanding on the borrower. High APRs and weekly payments can be a major stressor, both on the business’s cash flow and on the business owner themself.
But if you’re confident that you can meet those repayment terms—and you’re sure that your loan’s extra interest costs won’t cut too deeply into your cash flow—then a small business loan from an online lender may be the perfect fit for you.
Any personal loan you apply for will come in one of two forms: either a line of credit, or a term loan. That’s it.
But there are way more business loan types than that. Yes, you have your business lines of credit and short-term or medium-term loans. But you also have the option of applying for specialized small business loans, which are designed to help businesses address specific needs or projects.
Take equipment financing, for instance, which help small business owners pay for the expensive tools they rely on to keep their outfits up and running. In this instance, you’ll come to your lender with a quote for the tool you need to finance, be it a pizza oven or a point of sale terminal. If approved, your lender offers you the cash upfront to pay for that equipment, and you’ll pay them back, plus interest, over a predetermined amount of time.
Or consider invoice financing, another small business loan that’s both structured for, and intended for, a business-specific concern. B2B businesses that rely on accounts receivables might want to apply for this type of financing if their customers are lagging behind on payments. In this case, your lender will front you around 85% of the total value of your missing invoices in cash. You’ll repay that amount, plus fees, and receive the remaining 15% (minus fees) once you’ve met the terms of your loan.
You won’t find a personal loan that targets a business-related dilemma so specifically.
Forgive the gross generalization here, but it’s safe to say that the only small business loan more desirable than a traditional bank loan is an SBA loan. They’re flexible, low-cost, carry generous repayment terms, and they’re backed by the US government—although banks and other lenders themselves furnish the capital involved in these loans, the Small Business Administration guarantees up to 85% of the loan amount.
Because of this guarantee, lenders are actually incentivized to issue SBA loans to a wider variety of small business owners, even those who wouldn’t meet a bank’s strict standards.
That doesn’t mean it’s easy to qualify for an SBA loan—it’s still a bank loan, after all. And the application process requires lots of paperwork, which requires an investment in time, patience, and organization on your end.
But if you have the right background to qualify, as well as the diligence to bear the SBA’s lengthy application process and longer approval window, an SBA loan is absolutely worth trying for—and definitely worth pursuing over a personal loan.
Clearly, financing your business with a business loan makes the most sense, most of the time.
But securing a traditional business loan through your bank can prove challenging, especially for business owners just starting out and who can’t meet banks’ demanding loan eligibility criteria. Even though small business loan approval rates are on the rise, large banks are only approving 25.9% of the loan applications that come through their doors. That leaves about 75% of small business owners in the lurch.
For that reason, many small business owners have turned toward alternative financing to secure small business loans. And, as of June 2018, alternative lenders have approved 56.5% of their loan applications. That’s a huge step up from banks’ approval rating—but, of course, it’s still not 100%. Even though alternative lenders have created loans to suit a much wider variety of small business owners, they still do require their borrowers to meet certain standards.
So, if your bank or alternative lender turns down your business loan application—whether that’s because your personal credit score isn’t high enough, your business doesn’t have a strong enough cash flow, or your business simply hasn’t been open long enough—you could stray from the business loan path entirely and shoot for a personal loan from your bank.
But there are a few scenarios in which you might consider a personal loan over a business loan from the start:
In order for a small business lender to feel confident issuing you a loan, your business needs to speak for itself. A comprehensive business plan, reliable cash flow, and a visibly thriving facility all improve your chances of approval, because they’re all signs that your business is financially solvent enough to repay their debt—and has the track record to prove it.
A brand-new business owner may encounter obstacles in all of these aspects of their business loan application. So, if you’re still in the early stages of getting your business off the ground, you might have more luck getting approved for a personal loan.
Many banks are reluctant to issue small business loans in small amounts, because they yield less interest for the bank, but cost the same amount of work as a larger, more lucrative business loan would. If your desired business loan amount is less than $25,000, you’ll likely be out of range for a traditional term loan from your bank.
In that case, you can look for a business loan from alternative lenders, which can issue loans as small as $2,500. However, these loans come at a price. Because they’re made available to a wide range of borrowers, including those deemed risky by traditional lenders, loans from alternative lenders can carry pretty high interest rates. (That’s how lenders protect their interests.)
If the amount you’d like to borrow is small, get quoted for a personal loan from your bank. They might be willing to loan you the amount you need, at an APR you can afford.
After insufficient cash flow, insufficient collateral is the most common reason why banks deny small businesses loans. Generally, online lenders or SBA lenders won’t deny you a business loan if insufficient collateral is the only thing holding you back, but traditional bank loans may not be so lenient.
On the other hand, personal loans are unlikely to require collateral. If your savings or investments are looking thin, and if offering your home as collateral is out of the question, you may want to consider a personal loan.
Right now, you might feel like a personal loan is the standout choice for financing your business. When you apply for a personal loan, your lender only cares about your credentials, not your business’s, which can be a relief for brand-new entrepreneurs whose businesses don’t yet have any credentials to speak of. Plus, personal loan interest rates tend to be lower than those for business loans, and you probably won’t need to put up any additional collateral, like your home or savings, to secure your personal loan.
So, why shouldn’t you automatically pursue a personal loan for business? Because, if you can swing it, using a business loan for business financing is still the more logical choice.
For starters, separating your personal and business finances is a crucial tenet of responsible business ownership—and that’s not just because mixing up your business expenses with your personal expenses makes bookkeeping and tax filing more difficult than they already are.
If you do apply for a small business loan, your lender will look a little suspiciously (or at least with regret) on tax returns that consolidate both personal and business expenses. It makes the job of discerning your business’s credentials much, much harder on them, which won’t exactly help your odds of loan approval.
Beyond the logistical issues, mixing up your personal and business finances might actually jeopardize your personal assets if your company finds itself in a lawsuit, regardless of how your firm is legally registered. And if you default on a personal loan, even if it’s unsecured, your lender might sue you to recoup what you owe.
None of this is meant to scare you off from personal loans entirely, though—sometimes, using a personal loan for business truly is the best course of action. That’s especially the case for brand-new businesses, or soon-to-be businesses, that don’t have the credentials required to qualify for a business loan.
Bottom line? You have options. Evaluate your personal and business finances, your intended use for your loan, and work with a loan specialist to help you decide whether it truly makes sense to make your business a little more personal.