Many people see debt as a bad thing; there is even a pervasive myth that “no debt is a good debt.” But, here comes the paradox: For business-minded individuals, debt is far less ominous. Businesses, especially start-ups, consider borrowing money to open new doors and stay afloat until realizing a profit. They use debt to gain leverage, rather than getting weighed down.
According to Victoria Duff, a start-up facilitator who specializes in entrepreneurial subjects, the machine of commerce does not run without money.
“Money is the lubricant and the fuel. It makes possible the smooth design, production and marketing of a product; and it keeps the administrative functions efficient. Money also moves the company forward by fueling growth and expansion,” Ms. Duff wrote in an article posted on bizfluent.com.
She added that an entrepreneur can perform a lot of business model development without funding, but when it comes to building the company, funding is necessary.
“Start-up funding pays for incorporation, business licenses, insurance, facilities, equipment, marketing collateral and the hiring of necessary talent. It funds the manufacture of products and the marketing and distribution of services. It also pays for marketing activities that attract customers,” Ms. Duff said.
Borrowing money is one of the various options available for start-ups to meet the working capital requirements.
Borrowed funds help pay upfront expenses. According to Fora Financial, one of the leading providers of small business loans and business funding in United States, if the business requires a large initial investment, such as inventory or equipment, a start-up loan may be one way to get needed funds.
“Depending on your business’s industry, you may need more than you can borrow from savings, family, or credit cards to get off the ground,” Fora Financial said.
Borrowing money to start an enterprise is also a good option to retain business ownership. A start-up business loan may be the best alternative to seeking investors, who, in the succeeding years, may ask for a share of equity in the company.
“By funding their venture with a loan, entrepreneurs have more leeway when considering potential partnerships. For example, they have the option to choose investors based more on strategy, rather than monetary value,” the lending institution explained.
Moreover, borrowing money to start a business can help individuals protect their personal wealth.
Just as Fora Financial said, every new enterprise comes with risk, and even the most well-planned venture may face obstacles out of the founder’s control. “Entrepreneurs should therefore think twice about pledging personal wealth such as the equity on their home, retirement savings, or money they need to live.”
Through the years, the owner may eventually need a large cash infusion to further grow the business. In such cases, a history of responsible credit use is one important factor to qualify for a bigger loan.
“As with personal loans, having a strong credit history indicates reliability as a borrower, and lower investment risk for the lender. By taking out and paying back a smaller loan first, owners increase the chance of their business being approved for a bigger loan in the future. It may also help secure lower interest rates,” Fora Financial said.
Over the several advantages of borrowing money to start a business, there are also some downsides to consider.
First, not all businesses may qualify for a loan due to the strict rules and requirements laid out by financial institutions. From a lender’s perspective, start-up loans are a risky venture.
“New companies fall short in all the metrics banks use to determine loan eligibility: revenue, financial records, credit history, or proof of business longevity. The difficulty of obtaining a start-up business loan is perhaps its biggest caveat. This is especially true when the applicant lacks strong personal credit, assets for collateral, and large down payments,” Fora Financial said.
Also, borrowing money to start a business restricts cash flow to grow the business. Borrowers need to pay the interest and principal depending on the agreed payment schedule, and missing loan payments can mean irreparable damage to business and personal credit.
“Small business owners should consider how regular loan payments factor into their budding organization’s finances. Having monthly payment obligations could restrict cash flow to run or grow the business,” Fora Financial said.
While the lending institution said that borrowing money to start a business can help individuals protect their personal wealth, it also noted that having a business loan does not guarantee a protected one. It explained that: “Given the extra risk of lending to small businesses, many financial institutions may require a personal guarantee, which means banks can come after you for repayment if the business defaults.” This only means that even the personal credit score and assets of the borrowers may be impacted.
“There are pros and cons to pursuing a start-up loan, including issues concerning ownership, eligibility, risk to personal credit, and the cost of repayment. However, qualifying for a start-up loan could mean money to start a business unattached to family and friends, who may expect repayment, or investors, who may want ownership for their investment. Small business owners should weigh all considerations before deciding to move forward with a start-up loan,” Fora Financial concluded. — Mark Louis F. Ferrolino