The Pros and Cons of Using Startup Loans for Small Businesses

Small businesses require funding to get off the ground and establish their operations. These startup loans for small businesses provide the required capital for purchasing equipment or inventory and can even help with day-to-day costs until the business starts turning for-profit.

Unfortunately, startup loans for small businesses can be a challenge when it comes to their qualifications, as lenders want to see a track record of your business to be assured of loan repayment. You may have to approach lenders that provide you with startup loans. This will ask you for providing a personal guarantee, collaterals, and business plan to showcase your repayment ability to the lender.

When you are entering a space where you have to sign a loan agreement, you would have to look at the pros and cons of startup loans for small businesses and ensure that you are making the right decision. If not, you can fund your startup through alternative means, such as bootstrapping your business, applying for grants, or securing investors.

Pros of startup loans

There are several key reasons you may want to explore startup loans for small businesses.

Access to capital

Startup loans for small businesses provide you access to funds that you can use for multiple purposes, like starting your business. For example, lump sum options such as business term loans or equipment financing are generally used for high upfront costs, which are required by your business to run. Some of them are office equipment, product development, or semi-truck financing.

A revolving source of capital like a business line of credit can offer a revolving source of money to use when required, helping to cover everyday expenses. You would have to repay these loans with revenue generated by your business over time.

Possibly Help build credit

When you are selecting a lender that will report your payments to credit bureaus, getting a loan for your finances would be helpful, till the time you are making payments on time and keeping away from debt.

Building credit is a necessary step when you have a bad credit score, which makes it hard for you to qualify for startup loans for small businesses with affordable rates. Even if you are not in need of finances now, a loan or business line of credit can prove to be a good way for building credit if the lender reports to credit bureaus and ensuring that you are eligible for the best loan for your business whenever required.

There are some lenders who come up with different programs that help you build a secure credit, graduating to an unsecured line of credit in the future. You should never forget that not every business lender will report credit bureaus. Therefore, you should verify and confirm the details before applying for a business loan.

Retaining ownership

Startup business loans can save you the trouble of finding investors and selling equity, which means giving up partial control of your business. Depending on how much equity you sell, you may need to answer the demands of investors. With a business loan, you keep full ownership and can run your business as you see fit.

Startup loans for small businesses can help you save time looking for investors and selling equity, which means you will be giving up partial control of your business. This will also depend on the percentage of equity you are willing to sell as per the demands of the investors. If you are selecting loan options, you will have complete ownership of your business.

Cons of startup loans

If there are pros, then there are several drawbacks as well, which you should consider before exploring startup loans for small businesses.

Strict eligibility requirements

Securing business financing can be tough for startups. Traditional lenders often require a credit score of at least 600, a track record of two or more years in business, and annual revenue between $100,000 and $250,000. For many new businesses, those benchmarks are hard to reach.

In fact, according to the Federal Reserve Banks’ 2024 Firms in Focus: Chartbook on Firms by Revenue Size, nearly half 49%, of businesses under two years old report annual earnings of $100,000 or less.

While startup loans for small businesses do exist, the options are typically more limited. Some lenders may offer secured loans or accept lower credit scores, but you’ll likely face higher interest rates or stricter terms. Additionally, many of these financing options still require significant down payments, which can be another hurdle for new business owners.

Risk of default

If your new business doesn’t generate enough revenue early on, keeping up with loan repayments can become a serious challenge. Falling behind may lead to loan default, which can damage your credit and result in the loss of any assets pledged as collateral.

Statistics from the U.S. Small Business Administration show that only about 48.9% of businesses survive beyond five years. For those just starting, especially if profitability isn't expected right away, taking on debt may not be the best move. Instead of jumping into a traditional loan, it may be wiser to explore alternatives to an SBA startup loan, such as grants, crowdfunding, or partnerships, until your business gains steady traction.

Where to get startup business loans

If you have to look for an option for startup business funding, you can look for traditional banks, but they have strict rules for lending. Below are two options that are pretty accessible for your business needs.

SBA loans

SBA loans are known for requiring multiple documents and taking anywhere between 30 and 90 days for loan approval; still, they are an affordable and accessible option for startup loans for small businesses. SBA loans offer low interest rates and long repayment terms to qualified applicants. There are also microloan programs that provide loans for $50,000 or less and help to get started with the business.

Online lenders

Since startups and businesses that have just started face a struggle in securing traditional bank loans, there are multiple online lenders who have stepped in. There are those who specialize in working with startups, and these loans provide relaxed eligibility requirements and faster funding and approvals at times.

Alternatives to startup business loans

If you think startup loans for small businesses are not the right fit for you, below are some of the common alternatives that can be considered.

Business credit cards

Business credit is helpful when you are covering short-term business expenses. They are just like a business line of credit but come with unique perks like a discount on selected purchases, rewards, introductory APR offers, and more. As an entrepreneur, you can also use the business credit card for building business credit and even avoid interest charges when you pay your charges every month.

Business grants

Gov agencies, private companies, and nonprofit organizations often provide business grants. Unlike loans, grants don’t have to be repaid, making them an attractive option for startups looking to avoid debt. However, since many businesses compete for the same grants, the process is highly competitive.

Additionally, securing a grant can take time, often several months, before you learn if you’ve been awarded funding. Due to this delay and uncertainty, many new business owners opt for startup loans for small businesses instead, as these loans offer a more predictable timeline. To improve your chances with either grants or loans, having well-prepared financial statements is essential for demonstrating your business’s viability.

Bootstrapping

Bootstrapping is the process of financing a business solely with personal funds or operating revenue. This approach can be efficient in cases where the business’s overhead is low, such as running a consulting business from home. People who bootstrap a business often dip into their savings, take on personal debt, or cut costs as much as possible when starting a business.

Crowdfunding

Crowdfunding is a favorable option that involves using an online platform to run a fundraising campaign for small business financing. It will take your time and energy, rather than taking out a loan, as you will be raising a small amount of cash from different sources. You should know this is a feasible option for startup loans for small businesses.

Conclusion

Choosing the right type of financing is essential when you're launching a new venture. While startup loans for small businesses can provide the capital needed to cover essential startup costs, such as equipment, inventory, and overhead, they aren't always easy to qualify for.

It's important to carefully evaluate each type of loan and consider whether it aligns with your business goals and financial situation. If traditional loans don't meet your needs, options such as grants, crowdfunding, or bootstrapping may be more suitable. Ultimately, the best funding route is the one that supports your business's long-term success without placing undue strain on your finances.

FAQs for startup loans for small businesses

Is it worth taking out a loan to start a business?

Startup loans for small businesses are a good option for obtaining upfront capital for the launch and establishment of a new business. They may also build credit, which can lead to affordable loans in the future.

What are the disadvantages of starting a business with a loan?

Even though you may think that loans are the best option for your business needs, they come with certain limitations and the responsibility of repayment. It depends on the loan amount and terms, that your business may face a significant amount of debt that can affect your cash flow and financial stability.

What is the ideal loan for starting a business?

For starting a business, SBA loans, usually 7(a) loans or microloans, are generally recommended as they have favorable terms and government backing. Online lenders also provide quick funding, but the interest rates are high, while a personal loan is an option for those who have a limited credit history.

Is it hard to get a start-up small business loan?

Most lenders typically require a credit score of 600 or higher to qualify for startup loans for small businesses. However, some online lenders provide financing options to credit-challenged entrepreneurs with scores in the 500s. These loans often carry higher interest rates to compensate for the increased risk; however, they offer a viable funding path for new businesses with limited credit histories.

Why is it so hard to get a startup business loan?

Startup loans for small businesses face challenges while securing loans. They are not like established businesses and lack financial history along with a track record that lenders rely on for evaluating risk.

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