“Only morons start a business with a loan.” That’s the advice of billionaire Mark Cuban, rarely at a loss for words, owner of the Dallas Mavericks.
While Cuban makes good points in the interview, it also lacks 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 at university buying a local bar.
Times have changed and interest rates aren’t what they were in the 1980s. Even iPhone giant Apple Inc, with $63 billion in cash on its books, still owes $93 billion. of debts.
Borrowing for business is not only more dangerous, but could be the smartest financial decision you can make.
Why You Might Consider Using a Loan to Start a Business
Cuba’s point is that people underestimate the hard work and time it takes to run a new business. He argues that most startups fail, which often means owners are left personally responsible for the money, sometimes at risk of bankruptcy.
It’s a valid point, but there’s another side to the story that he doesn’t mention.
Most new businesses fail due to a lack of capital, not being able to raise the money needed to continue operations. More than three out of four businesses operate for up to five years before running out of money because sales can’t keep up with expenses.
So it turns out that getting a loan might actually keep you in business rather than ruin you.
Loan rate to start a business
Business loans and other types of loans are among the cheapest forms of debt in terms of interest rates. For example, private business loan rates 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 rate of around 14% is less than the cost of using credit cards or equity financing to start a business. Equity financing, an interest in a new company through a partnership or investorsrequires a high expected rate of return. Investors are not going to put their money unless they think it will lead to high double or triple digit returns. 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 the assets of the business back the money. Lenders can repossess or force you to sell business assets to meet loan repayments.
This is not the case with a personal loan which requires no collateral. You will not be forced to sell your home or other assets and cannot be pushed into bankruptcy with a personal loan. This peace of mind for the borrower comes with a higher interest cost.
Business loans are usually at much higher amounts. For example, some business lending sites fund small business loans up to $300,000, while most personal lending websites lend $40,000 over three or five years.
There’s probably no single answer as to the best loan for starting a business, but it might be a pointless question anyway. More 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 a personal guarantee, so they won’t always protect you against the loss of 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 may qualify.
Using a personal loan to start a business
Although using a personal loan to start a business can be a good financial decision, there are some things you need to remember before borrowing money.
Start the business with as much money saved as possible, at least to the point of having a workable business plan and approaching sales. Payments on a loan will start in a month, so you’ll need a way to start making them either through sales or by using the unspent loan.
If the business income is not growing fast enough, you will be forced to dip into your savings or scramble to make payments.
Startup Business Loan Rule #1
Take the business as far as you can with your own money and only take out a loan when sales are close.
I would also recommend only using a personal loan for a low capital type of business. The internet ushered in the era of low-cost businesses, from Amazon FBA to a service website.
For example, it cost at least $100,000 to start a retail business with manufacturing costs and a storefront. You can now start one with as little as $5,000 through Amazon or Shopify. This means that a $10,000 personal loan can give you enough to start the business and have a cash cushion to make payments while sales increase.
This will rule out many types of traditional businesses that still cost tens of thousands of dollars to start, but it is by far the safest way to start a business.
Startup Business Loan Rule #2
Only use a loan to start low-capital types of businesses that can start with $30,000 or less.
Finally, be sure to balance the prepayment of the loan with the cash flow needs of the business. It’s tempting to push all the cash flow to pay off the loan, but it can spell trouble if that cash flow dries up for a few months. In times of drought, you don’t want to fall behind on your payments, so keep a cash reserve and plan for expected sales for the year.
Startup Business Loan Rule #3
Plan for expected cash requirements for the year and maintain a reserve of cash to make loan payments.
How to qualify for a business loan
Qualifying for a personal loan is easy and the application takes less than three minutes. You’ll need a minimum credit score and at least part-time employment to qualify on most websites, but that’s usually it.
Getting a business loan is more difficult and will take longer. Most business loans will take at least two or three weeks to be approved and processed. This includes time to check financial statements and bank statements.
The minimum requirements for a commercial loan are generally one year or more in current business and sales. Getting the best rates means higher sales in the $100,000+ zone and sales from repeatable sources.
Despite the difficulty of obtaining a business loan compared to a personal loan, you should always consider it as a source of funds. You will have access to more funds; even a 1% interest difference can mean tens of thousands in savings.
Getting a loan to start a business is no longer the potentially negative decision it used to be. There are good reasons to consider borrowing to fund your startup. Even multi-billion dollar companies 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 get the best rate.
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This article was produced and syndicated by Geek Wealth.