What's At Risk When You Take Out a Small Business Loan
If you're running a small business, you'll likely need to raise some capital at some point. There are many options for doing so—including borrowing from family or friends, taking out a small business loan from the bank, or relying on your credit cards. But no matter how you scrape together funds, it's essential to consider how you will pay them back.
We used industry sources and news coverage to compile a list of potential risks in borrowing money to fund a small business. According to a small business report by the Federal Reserve, nearly 3 in 4 firms with paid employees had outstanding debt in 2021. Companies will have to pay those loans back over time, burdening their business's revenue.
Those who want to avoid loans or credit card debt may seek investors and offer equity in their business. However, this strategy has its own risks. The more ownership you offer to outside investors, the less control you have over your business strategies.
No matter what type of business funding you decide to pursue, make sure you understand the long-term consequences and risks that come along with it.
Defaulting on a loan
A traditional loan from the bank might seem like the most obvious solution when you're looking to raise money for your small business. There are a few options here, including a traditional business loan from your banking institution or one backed by the Small Business Administration. SBA loans are typically a bit easier to get approved, as they are backed by the government and pose less risk for lenders.
No matter which loan you take out, defaulting or failing to make payments will have severe consequences. You will lose any collateral you've put up, and your business and personal credit scores can take a hit. Most SBA loans require a personal guarantee, meaning your lender can seize your personal assets if you can't cover the cost.
It's critical to have a repayment plan before borrowing money and to take only what you need.
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An alternative to a small business loan is to pay for business expenses using a personal or business credit card. A credit card can ensure you can pay vendors on time when your cash flow is irregular, as you can pay off your bill later or over time.
That said, credit cards are not a reliable source of significant funds. Most credit cards have very high interest rates that can get out of control if you can't pay back your debts. The current average business card APR is 20.46%, and because credit card APRs are almost always tied to the prime rate, you could be subject to increases and fluctuations over time.
Not to mention, credit cards don't come with a set payoff schedule like a loan. You'll have to be disciplined with monthly payments to avoid burdening yourself with debt for an extended period.
If you're worried about the implications of borrowing money from a bank or credit card company, you could consider seeking angel or venture capital investing to fund your business. In this case, you'd offer equity in the business in exchange for securing the funds you need to keep it running.
The risk in this method comes if you transfer too much control into the hands of investors. The more equity you trade away, the less control you have over your business. Think carefully about how much sway you are willing to part with and how much you trust the input of the investors you bring on, especially if you offer a majority share.
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Finally, borrowing money from friends or family could be an alternative if you either don't qualify for funding from the bank or worry about paying it back. You could also score a deal on repayment terms and interest with the right lender.
Still, this is very dangerous to personal relationships. A 2022 CreditCards.com survey found that among people who lend friends and family money, 59% had a bad experience, including not getting their money back or damaging their relationship. If the relationship is important, consider how borrowing money might change it.