Without capital, you can’t finance a business. You can use your own savings to build your capital. But most entrepreneurs either borrow money or get alternative funding.
Borrowing money sounds intimidating. You have no guarantee that your business will profit, putting you at risk for defaulting on the loan. However, it’s a faster way to obtain capital than getting alternative funding. You just need to submit the requirements and prove your ability to repay. The lender receives security through collateral, too. If you fail to pay the loan, at least they can seize an asset of yours that can make up for their loss.
But that’s also the catch in business loans. Even if you willingly provide collateral, it doesn’t make the risks any less threatening. You can avoid providing collateral by getting an unsecured business loan, but that often has higher interests and shorter terms.
So is taking the risks of a loan worth it, or should you just go for alternative funding?
Secured Business Loans
A secured business loan is the most common and straightforward lending option for entrepreneurs. It’s backed by collateral, which can be your personal asset or the business’s. If you default, meaning you became incapable of repaying the loan, the lender can seize the collateral and sell it to recoup their loss.
Below are the types of collateral often used for secured business loans:
- Personal cash
- Unpaid invoices
- Real estate
Entrepreneurs usually choose a secured business loan because of its affordable interest and longer-term. And despite the collateral involved, it actually has lower risks. The reasonable interest makes the loan much cheaper than an unsecured loan. The longer terms, meanwhile, give more time for entrepreneurs to pay off the loan. These two perks allow you more leeway to settle your debt.
You can get a secured business loan from banks or the Small Business Administration. SBA loans can be secured or unsecured. Secured SBA loans also have collateral, but for small loans up to $25,000, the SBA isn’t required to take the collateral.
Unsecured Business Loans
As its name suggests, you’re not required to provide collateral for an unsecured business loan. If you have a high credit score, you are a good fit for this. Still, the risks will be greater for the lender, so chances are they’ll put up stricter requirements and less favorable terms.
If you default on an unsecured business loan, the lender might sue you. Entrepreneurs who have been sued can file for bankruptcy to relieve themselves of the loan. A bankruptcy lawyer can help plead their case and set up a repayment plan to satisfy the lender. If you rather take the risks of going to court than giving up collateral, then an unsecured business loan may suit you more. But you’re not totally free of collateral with this loan. Some unsecured loans require a personal guarantee. That means giving the lender the right to appropriate your assets if the business defaults on the loan.
Hence, an unsecured business loan is the best option only if you urgently need cash and are sure to pay it back in a short time.
For startups, two alternative funding options are the most common: crowdfunding and venture capital funding. Crowdfunding is obtaining a small amount of capital from numerous individuals, usually through the internet. You’ll just create an account on a crowdfunding site, present your business idea, and wait for “donations,” which will make up your capital.
There are also risks in crowdfunding, especially on the side of the contributors. To protect them, crowdfunding sites set a restriction on how much they can contribute. This helps them keep their losses to a minimum if the startup fails.
On the other hand, venture capital funding is looking for a smaller group of investors and persuading them to contribute capital to your business. This gives the investors a stake in your business, but it can also give you an advantage loans and crowdfunding cannot. If your investors happen to be well-known figures in your industry, they can help promote your business and expand your network. Within a short time, you can get connected to other industry leaders and receive perks from them.
Each financing option has risks. Hence, your choice should depend on the risks you’re willing to take. Getting a loan means to risk defaulting. Getting alternative funding is to risk wasting your investors’ money if your business fails. If you’re not the risk-taker type, the loans may suit you more. At least, your losses are only yours to bear if you default on the loan. It will be easier to start over if no other investors are affected by your inability to repay.