What is best: Business loan or personal loan for your startup?

Trying to decide whether to go for a business loan or personal loan to fund your startup can be tricky.

Generally speaking, if you’re a sole trader, a personal loan could be the right choice.

However, if you’re set up as a company, a business loan may be a better option, depending on how it’s structured, according to Kane Munro of Accountancy Online.

“Obviously when you’re just starting out, you don’t have a track record to show the bank, so you’re well within your rights to go for a personal loan to fund your startup,”Munro says. “However, at some stage, you’ll need to tell your lender what the money is for.”

When assessing your eligibility for either loan, the lender will consider your employment history, savings track record and earnings, he says.

“A loan is a far better way to go than re-drawing on your mortgage to launch a startup. You should never stake a house or car on a startup, and make sure you only ever borrow what you can afford to lose,” Munro says.

A personal loan of up to $20,000 isn’t too difficult to secure from most lenders, however beyond that you’ll need to provide greater detail on what the money will be used for, he says.

Every situation is different, so make sure you compare packages from your chosen lender before signing on the dotted line, advises senior manager, marketing of accounting firm The Practice, Brendan Keogh.

If you’re going with a business loan, you will be offered either a term loan or business overdraft. A term loan offers a finite term of usually five to 15 years, by which time it will need to be paid back in full. An overdraft facility, on the other hand, is used to fund working capital and if the facility isn’t drawn down, no interest is charged for the month, Keogh explains.

The next decision you need to make will be whether you want a secured or unsecured loan, he says.

An unsecured business loan is more difficult to obtain as the bank has little chance of recouping the funds if it isn’t paid back. And as a result of the bank taking on more risk, they charge a much higher interest rate, Keogh explains.

“By securing a business loan with property, it significantly reduces the interest rate as well as increasing the probability of the funding being approved by the bank due to the perceived risk the bank takes on,” he says.

“The negative from the business owner’s perspective is that it increases their risk in the event that the business fails, exposing the property to be sold if the loan is unable to be paid back.”

When shopping around, be sure to ask if the loan has a pre-payment penalty in case you want to pay down the loan completely, Keogh adds.

“I’ve seen business owners pay down loans without gaining any benefit. The money would have been better in a high interest saving account and only paying off the minimum requirements.”

However, bear in mind that it’s very difficult to swap from a personal loan to a business loan from an administrative point of view, advises the founder and co-director of LoanDesk, Leigh Dunsford.

“It may be more difficult to secure a business loan when you’re starting out, but it may be a better way to go. That way, when you’re 12 months down the track and need additional funding, you’ve got a track record, so you don’t have the hassle of proving your personal loan was funding your startup.”

And remember that being stuck on a smaller credit limit can be a massive hindrance, especially if you experience an unexpected growth spike.

It’s best to discuss your projections with your banker and plan for adequate cash flow over the first 12 months, Dunsford adds.

Startups need to be realistic. A stable income from a job, a partner able to support you, or income from an investment property is an ideal way to pay the bills so you can reinvest back into the business, he says.

“I’ve seen it time and time again. Startups that really thrive are the ones where the business owner doesn’t have to pay the bills out of the money made from the business in those early days,” Johnson says.

Written by: Nina Hendy

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