The Pros and Cons of Small Business Bank Loans

Nobody likes to ask for money but as a business owner, sometimes—often times—it is necessary. You can ask people you know but being on the hook to loved ones is not only awkward but also puts them in the position of having to break one of those unwritten rules: Don’t lend money to family and friends.

For businesses further along in their growth, venture capital or angel investors might be an option but even in a recovering economy, getting a meeting with them is difficult.

Bank loans are still the funding method of choice for small-business owners but if they are new to you, consider the pros and cons before applying.

Why Bank Loans are Popular

Bank loans come with autonomy. The lending officer might ask you about your plans for the funds but once the bank approves the loan, they won’t be concerned with how you use it unless it’s a large loan for a specific purpose.

Next, you don’t have to give away part of your company. If you were to partner with a venture capitalist or angel investor, the standard terms include giving away a portion of your company. For young companies, that portion (known as equity) could be higher than 50 percent.

Finally, the terms are better. In the beginning, you might have financed your company with your credit card. That came with high interest rates and a limited credit limit. Bank loans often have lower interest rates, higher credit limits, and as you build your small business credit file, paying back a bank loan carries more positive weight than a credit card.

The Drawbacks

You’re going to have to make it through the application process. Because the bank is taking all of the risk, it will want to know a lot of detailed information about you and your business. The bank will want to see your financials, revenue projections based on sound data, information about other investors and their stake in your company, and operating documents.

Especially if your company is small and young, the bank will want to know about you. Be prepared to disclose everything about your family finances. Then, much like a meeting with investors, you’ll have to answer some tough questions. (And, you’ll need really good answers.)

Banks are cautious in light of the credit crisis that is still fresh in lenders’ minds.

It’s likely that the bank will require you to personally guarantee the loan. If your company defaults, you may lose your home, your car, investment portfolio or other valuables.

Take Action

Despite the drawbacks, banks are still the best source for small business funding. Before you apply for a loan, talk to various lenders about their terms, interest rates, and various types of business loans.

Finally, make plans for the future. This is where being the hopeful optimist can be your downfall. Before applying for a loan, ask yourself what will happen if business slows down? What if the economy has an effect on your business that is outside of your control? Can you still make your loan payments even if business slows?

Don’t take on a loan that relies on your business performing at its peak in order to make the payments.

For more information on small business funding, check out our webinar, 10 Tips for Raising Finance.

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