Entrepreneurs who have their own startups often resort to personal savings or funding from personal connections or crowdfunding, etc. to raise capital to invest in their business. Now these funds can often not be enough to get a company started and it might also take a lot of time to acquire the funds required.
So taking a loan can be an interesting option to look at for startups wherein they get the money that they require exactly when they need it. However it is not an easy decision and they should check out all the aspects of this option first.
| Pros of taking loan for startup | Cons of taking loan for startup |
| Taking a loan provides the necessary capital investment | It is extremely hard for startups to qualify for a loan from financial institutions like banks |
| The startup can hold on to full ownership of the business | Taking a loan means monthly payments to the lender, severely restricting the cash flow |
| The entrepreneurs’ personal wealth is kept separate from startups’ wealth | The extra money can retard the creativity in the startup entrepreneurs |
| Repaying loans on time, garners extremely important business credit | Banking institutions can secure a personal guarantee for loan repayment |
| Banking institutions have multiple loans advertised to attract business ventures | Startup Entrepreneurs having very little practical experience with their respective companies |
| Taking a loan is a temporary arrangement | Startups are often left with very few souces to secure a loan |
Advantages of taking loan for Startup
- Capital :
At the onset all types of businesses require a basic investment of working capital that will cover all the initial needs like inventory cost, equipment cost, rent payment, salary for employees, miscellaneous costs, etc. The funding required may be too high to provide for personally. Taking a loan helps the startup push off the ground.
- Ownership :
A loan can be the viable alternative instead of seeking out investors who can demand a share of the company’s equity in exchange for providing the funding. A loan lets the startup keep complete ownership of the company and provides more freedom when potential partnerships come along later on, which can be crucial for startups.
- Personal Wealth :
A loan helps a startup to keep their personal wealth completely separate from the company’s wealth. Any new venture always has it’s own set of risks and startups often undergo unforeseen obstacles. The loan relieves the startup entrepreneurs of having to jeopardise their own finances while trying to open their own business venture.
- Business Credit :
Startups often require a huge influx of cash as they keep growing. It helps their chances of securing a big loan, even with lower interest rates, if the company has a strong credit history. So it is preferable to take a small business loan at the beginning of the startup and pay it back on time, to indicate reliability.
- Multiple Loans :
Financial Institutions like banks offer a plethora of schemes to get businesses to work with them. For example they can offer to make the terms of repayment quite flexible. The number of schemes banking institutions have on offer, startups can have a chance to find a loan offer that can be repaid easily when the company thrives.
- Temporary :
The loans taken from banking institutions are temporary. So, once the startup has paid the loan back, they no longer have any obligation to or involvement with the institution. This is much more beneficial than the company, as long as it exists, having to pay dividends to lenders who have acquired equity in return for their loan(s).
Disadvantages of taking loan for Startup
- Qualifying :
Startups can be a very risky investment, as they tend to fall short in arguably all of the metrics used by banking institutions to decide eligibility for a loan, including revenue generated, records of finance, reliable credit history, proof of longevity of business, etc. So it is extremely difficult for startups to even qualify for a loan.
- Cash Flow Restriction :
Loans typically require monthly servicings with payments made in some combination of the interest and the principal. These monthly obligatory payments can severely restrict cash flow, proving to be detrimental for a growing startup. Missed loan payments can destroy a businesses ability to secure future loans and so startups need to factor these into their finances beforehand.
- Less Bootstrapping :
Limited funding can motivate startups to come up with creative solutions to their problems so that they can stretch their funds as much as possible. However the extra influx of cash from the loan can tempt businesses to fix issues by simply spending more and then not having enough funds left to pay back the loan.
- Personal Credit :
The added risk attached to lending money to startups means that banking institutions often secure a personal guarantee from the entrepreneur(s) that the amount will definitely be repaid in full. This means they will go after the entrepreneur in case the business defaults in the repayment. This can impact even your personal credit score and/or personal assets.
- Limited Knowledge :
Startup Entrepreneurs have had very little practical experience with their respective companies. So, while experienced entrepreneurs, know exactly how to best use the loan money to grow their business further, startup entrepreneurs simply do not have that much of a data pool to work on, owing to the limited time, they have been in operation.
- Limited Sources :
It is very hard for startups to actually find someone to lend them money. Most of the alternative lenders and also lenders online have strict policy of not supplying finance to startups. Startups often cannot meet the time in business requirements loan providers, as in being operational for a minimum of six months, etc.
So ownership, personal credit, capital to invest, eligibility, are just a few of the many pros and cons that are associated with a startup trying to take a loan to conduct it’s business. It can definitely help a startup financially, but it would need constant monitoring. In the end it is always better to weigh in all options and know your business and it’s functions in and out before attempting to secure a loan for your startup.
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Business, marketing, and blogging – these three words describe me the best. I am the founder of Burban Branding and Media, and a self-taught marketer with 10 years of experience. My passion lies in helping startups enhance their business through marketing, HR, leadership, and finance. I am on a mission to assist businesses in achieving their goals.