Small business financing can be a tricky subject, especially for first-time business owners. Deciding between lines of credit, secured and unsecured loans, private equity, and crowdfunding can be a headache in itself. With so many options available, you may be tempted to borrow what you need. Personal loans can be used for many reasons, including funding a nascent business. Using a personal loan to fund your business might or might not be a good idea, depending on your personal arrangement.

Business Loans:

Business loans and personal loans can look very similar at the surface level. They’re structured in similar ways with a renewable line of credit or a lump sum that is repaid in payments or interest. Both business and personal loans can come from banks, online lenders, and credit unions. So, what are the differences between the two? Let’s take a look.

Business loans are strictly for financing a business. Covering payroll, having a second location, renovating a location, restocking inventory, and getting cash for unpaid invoices are all valid business expenses. A business loan uses your company’s financial reputation and credit and cash flow history as proof that you’ll be able to repay the loan. Business loans tend to be for much more than personal loans, so banks and financial institutions are very selective when choosing business loan candidates. A business loan application will also include lots of paperwork since banks want to verify the business is liquid.

Personal Loans:

Personal Loans are different from business loans since they are designed to finance personal matters. Sometimes, that includes starting or augmenting a small business. Lenders will look at the borrower’s personal income and credit score to determine the loan’s rate and terms. Your personal credit score hugely impacts whether a financial institution will grant you a personal loan. Having low credit means you will have a hard time finding financing for a personal loan. Personal loans typically have more flexibility in the reasons you can qualify for one and usually have lower interest rates.

Personal loans might be viable for business owners who can’t meet some of the stringent criteria required for a business loan. On average, only 25.9% of all business loan applications in the United States are approved. That means roughly 75% of small business owners need to find an alternative form of funding. This fact alone makes personal loans a better candidate for most first-time business owners. Alternative lenders approve 56.5% of their loan applications, making them more attractive than banks in many cases.

First-time business owners should compare and contrast a variety of lenders for both business and personal loans to find the best option. Never go with the first offer that presents itself, as you have no comparison on which to base its performance. Have a comprehensive business plan that you can share with lenders, as well as cash flow stats readily available. Banks often deny small business loans of less than $25,000, just because they aren’t very profitable for the bank. A personal loan may have better odds of approval in this range.

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