Using personal credit cards is one of the most common ways entrepreneurs start their small businesses. Raising money from family and friends can create tension in relationships and traditional lending institutions often shy away from companies that aren’t yet generating revenue. For that reason personal credit is one of the most relied upon resources new business owners use when first getting started.
In this article we’ll cover some of the benefits and pitfalls to bootstrapping your company with personal credit and what to do once the company is off the ground.
Nearly 40% of new business are financed with money raised through friends and family. However, personal capital networks are often limited and aspiring business owners can be left with significant shortfalls. What most businesses need is a commercial loan but banks will often only lend to businesses with an established track record. A personal loan can provide the financing you need to bridge the gap between your startup and the established business it will become.
What are the specific differences between business and personal loans? The biggest factor is which revenue streams the bank reviews to assess the viability of the loan. For a personal loan a bank will review your personal income. This can be income from salaries, rental income, and even retirement and disability income. For a business loan the businesses revenue must support the loan on its own which can make it difficult for businesses that aren’t yet generating any revenue currently to be qualified.
A common misconception of business loans is that they allow the owners to protect their personal assets in the event of a bankruptcy. While this is true for many large companies, for small and medium-sized businesses most banks will require a personal guarantee from all majority owners. This isn’t quite the same as putting up collateral but it does allow the bank to pursue the owners’ personal assets in the event of a bankruptcy.
Bank and Credit Union Loans
The best place to start is often through you bank of local credit union. Hopefully you have developed a good relationship and often times local institutions have good incentives to offer financing to support their local community. However, getting a personal loan to start a business can be tricky because the business will often use your personal income to assess the viability of the loan and if you will be severing that income stream then the bank may decide to decline your application. For that reason, it is always a good idea to try to maintain your existing employment, at least initially. It will help you secure the financing you need and it will give you the essential cash flow you need to give your business the best chance of succeeding.
Home Equity or Other Collateral-Backed Loans
A recovering housing market means that home equity is another great resource for startups. If you have equity in your home it can make you eligible for some really great financing options. Most banks will lend 80% loan to value, meaning they will give you the difference between 80% of your home’s value and what you currently owe on your mortgage. These loans are excellent resources because they often have 10-year terms and competitive rates, meaning you can spend more of the money on starting your business.
Transitioning Personal Debt to Business Credit
One of the most common complaints of new business owners is that they’ve accumulated personal debt starting their business and now they’re having trouble refinancing it into the business name. This can be a tricky situation because many lenders don’t allow personal debt to be refinanced into their new business loan. Common Funding, working with a handful of excellent lending partners, can refinance personal debt quickly and easily and even help liquidate business credit cards into cash to use for your small business.
No matter how you do it the most important thing is that you get your business the capital it needs to succeed. No one wants to pay more on interest than they must but often times speed of deployment and access can be more important. Cash flow is one of the most common reasons new businesses fail so don’t let access to capital be the reason your business isn’t able to execute on its goals.