Deciding how to finance a small business can be a complicated and challenging task for many entrepreneurs. There are multiple equity and debt funding options that can be used to kick-start a business and all of them have pros and cons. When it comes to small business loans, the following list of considerations should be factored into your analysis of whether this particular financing option is the right for you.
Small business loan benefits:
- Retaining equity
- As an entrepreneur, one of your goals should be to retain as much equity as possible in the company you’ve dedicated your sweat and tears to building. One of the perks of using a small business loan to finance your business is that you do not have to give away part of your company ownership, as you do in equity financing.
- Small business loans generally come with a high level of autonomy. The lender will generally ask what you plan on doing with the money, however they will not be overly concerned with the specific details of how the loan is being used.
- Preferable terms
- Small business loans generally come with more preferable terms, such as a lower interest rate and higher credit limit. Other financing tools, such as credit cards, can often have high interest rates and a limited credit limit, which can limit their flexibility and long-term payoff.
Small business loan challenges:
- Personal guarantee
- If your company does not yet have a track record or has limited cash flows and assets, the bank may ask you to put a personal guarantee on your loan. This personal guarantee could be a car, home or other valuable assets you own. If you default on the loan, you may lose this asset which you have guaranteed as collateral.
- Credit history
- If your credit history is not in good standing, it could impact what loan options are available to you. For example, you may not be eligible for the most preferable terms of the loan of your choice.
- Higher debt-to-equity ratio
- Withdrawing a small business loan will mean that you will have a higher amount of debt on your balance sheet, which will increase your debt-to-equity ratio, a measure of a company’s financial leverage.
- Impact of the economy
- Getting a small business loan can be affected by the state of the economy, which is something you do not have any control over. For example, if the economy is in a credit crisis where there is a reduction in the availability of loans and credit, banks may be very cautious in lending to a small business owner, especially given the high risk associated with young startups.
There are pros and cons to all funding options. It is up to you as the owner of the business to determine the best way to finance your business. The important thing is to consider all of the available options and weigh the advantages vs. disadvantages of all of them. At the end of the day, you need money to get started and a small business loan may be the right funding option for you. If you are considering a small business loan, take the time to speak to several lenders about their terms, interest rates and various types of business loans before you make your final decision.