Although business loans and personal loans are fairly similar in principle, there are a few differences worth noting. The methods by which a business chooses to structure its debt and manage its cash flow are often the difference between success and failure. Read on for some of the critical intricacies in the small business loaning process.
Knowing When to Use a Loan
One mistake made by many new business owners is choosing to take out a lot of different loans right out of the gate instead of looking for other ways to secure funds or structure the business. Even though loans are always an option, you should be minimizing the number of notes you’re issuing early on until you’re able to firmly establish a customer base and cash flow. Before you sign off on a loan, consider the following alternatives:
- The shoestring budget: Though it may not be the most glamorous decision, the reality is that many businesses can be operated using a shoestring budget early on. Be sure to consider, however, whether it is possible to run the business online or by using a spare room.
- Speak with your loved ones: This might seem a bit strange at first, but you might be surprised by the willingness of your friends and family to support you in your endeavor. Though these are still technically considered loans, terms are often more favorable in this situation than those offered by a financial institution. Keep solid documentation so you know how much these people are owed later on.
- The equity option: It is also possible for you to sell an equity stake of the business for an agreed upon amount of money. This does not require repayment, but instead, serves as a kind of investment. However, keep in mind that this involves losing some control and giving up a portion of future profits.
Places to Secure a Loan
While the principles behind them are similar, commercial and personal loans are available through many different providers. Banks and credit unions are two of the most common places to approach. However, there are government organizations, such as the Small Business Association (SBA) and other more local entities that are able to help you out. Because these organizations are subsidized by the government on several levels, you will often be able to find loans at discounted rates.
When you make a decision on your lender, the fundamental document for the loan agreement is known as the promissory note. In it, you promise to repay the lender a set amount of money, called principal, over a certain time frame with a specified interest rate.
If your loan is coming from a friend or family member, it is no less important for you to get the agreement in writing, as this is a great way to clarify terms so that the relationship isn’t put at risk over some future misunderstanding. Additionally, written agreements are important if at some point you are audited by the IRS, as the government might view loans from loved ones as gifts otherwise.
You shouldn’t just sign on for a loan with the first place that makes you an offer. Shop around with different entities to see which one is willing to give you the lowest interest rate. Check your state’s usury laws before you sign any documents, as you might otherwise engage with an interest rate that is illegally too high. On the other end of the spectrum, you don’t want the rate to be too low, as this can be a red flag to the IRS, which could interpret the loan as an investment, having severe effects on your business’s ownership and taxes.
These are a few of the basic principles of which all new business owners should be aware before jumping into a loan. Be wise with your spending, stay informed and you should be set up for success.
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