India is known to have the third-largest number of start-ups across the globe. With this rigour of entrepreneurial energy and passion for business, it is natural to require access to affordable capital. Small businesses thrive on funds and can continue growing only when they have sufficient backing of funds.
Funds or loans come in different forms and sizes, but the primary ones that are often required by borrowers are business and personal loans. These two loan types are different and are required for different purposes. A lot of times though, personal loans can be used for business reasons. For that reason, it is important to understand if one should do this and if yes, under what circumstances it makes sense to use a personal loan for your business.
Young entrepreneurs often find it difficult to choose between a business loan and a personal loan. While there is no right or wrong answer, an in-depth evaluation with regards to the context and life cycle of the business can enable them to make an informed decision.
Here, let’s try and analyse if it makes sense to take out a personal loan for business.
Understanding Business Loan and Personal Loan
Business loan – Business loans generally come in the form of short-term loans, line of credit, equipment financing, etc. These are meant for a specific purpose and are generally offered by lending institutions to help in the growth of a business and also to fulfil financial needs for regular functioning. The amount of loan offered, loan tenure and other terms and conditions are often fixed depending on the borrower profile and the objective of sourcing a loan. Rate of interest in the business loan is generally competitive and the loan comes with a collateral requirement.
Personal loan – Personal loans are designed for individuals who require funds for various purposes. Whether it is for buying a new gadget or to meet marriage expenses, personal loans come with the flexibility of using the money as per the borrower’s needs. The tenure on such loans is usually low, but the interest rate charged is often high. Personal loans come without any collateral requirement and hence these are often preferred by borrowers. Always check your credit score by visiting CreditMantri before applying for a personal loan.
Factors to be Considered While Sourcing Personal Loan for Business
Personal loans are crafted by financial institutions to specifically cater to a borrower’s personal needs such as wedding expenses, financing of home improvement, or some urgent financial needs. The interest rates on such loans are often high. Entrepreneurs who choose personal loans instead of business loans will have to incur a higher cost of funds and this could have a negative impact on newly incorporated business.
Shorter Loan Tenure:
A personal loan comes with a shorter repayment tenure as compared to a business loan. Thus, entrepreneurs have to pay out more EMI every month. This could, in turn, impact the cash flow of the business. If the business has just started its operations, it could be difficult to meet such cash flow commitments.
Future Lending Conditions:
When an entrepreneur chooses to fund his or her business using personal loans, the interest very is high and same is the case with EMI pay-outs. This increases the probability of a default and there could be cash-flow troubles for the business. In such a case, it can be difficult for the business to establish credibility and seek attractive lending terms for loans borrowed in the future.
Funds Used for Personal Expenses:
Since it is a personal loan, business owners could use the funds for any emergency personal requirement. This can cause a lack of discipline and mis-apportionment of business funds towards personal needs. This, in no way, drives business growth. A business loan can help in avoiding any such problems.
A Better Alternative: Consider Government Scheme Benefits for the Growth of your Business
For businesses that qualify for the credit guarantee scheme of the government, they can get collateral-free loans of up to Rs. 1 Crore. Thus, a larger business loan with a better interest rate can work well for a business as compared to a personal loan. On the other hand, a personal loan of Rs. 1 Crore without collateral can prove to be expensive for any business which is just starting.
While a personal loan can be availed instantly by fulfilling the basic eligibility criteria, it may sometimes help in addressing an emergency business need. It is not always advisable to take a personal loan for expanding your business. Smart entrepreneurs would prefer a business loan for future sustainability.
Factors such as the amount of loan required and criticality of the situation can influence the decision between a business loan and personal loan. If the loan amount required is too high but the business is faring well over the last few years, there are better chances of obtaining a business loan at reasonable interest rates. When it comes to the urgency of the requirement, a personal loan can be easily available as compared to a business loan.
Any business requires funds to manage working capital needs, expand and build infrastructure, pay employees, etc. The amount required is often substantial and it will help the business to ensure that the cost of raising capital is affordable and sustainable. Thus, business loans are ideal to fund the growth of any business as compared to personal loans. If an entrepreneur is just starting and is unable to make use of personal savings, or raise seed capital, business loans can be very useful to entrepreneurs. These offer a better chance towards the sustainable growth of the business.
Any entrepreneur must work towards nurturing the ambition of setting up a great business empire. For those who wish to create an everlasting brand image for their business, a business loan is an ideal choice as compared to a personal loan.