Personal loan for business: what you should know

What is a personal loan for businesses?

A personal loan is financing provided to an individual consumer. It’s generally unsecured and repaid in fixed monthly installments over a short period (24 to 84 months). Many personal loan companies allow you to use the loan proceeds to pay for virtually anything. So, unless your lender prohibits it, you can use a personal loan to fund your business.

That said, if you decide to use a personal loan to fund your business, you’re putting your personal credit on the line. You’re responsible for repaying the personal loan no matter what happens to your business. If your business can’t afford the loan or closes, you’ll have to make the payments on your own or risk harming your personal credit and reputation.

How can I use a personal loan for business expenses?

Tell your lender upfront that you plan to use personal loan funds for your business so you know if it’s allowed. Once the loan is approved and funded, you may use the proceeds to pay for your business expenses.

A couple of well-known lenders offering personal loans you can use to cover business expenses are Upstart and FreedomPlus.

Personal loans versus business loans

A business loan provides financing to companies to pay for business expenses, fund large purchases or even cover short-term working capital needs. The requirements to qualify for a business loan vary by lender and loan type. However, most lenders evaluate the business’s repayment capacity, capital, credit history and collateral when reviewing a loan for approval.

When considering a loan, make sure to compare the pros and cons of both personal loans and business loans.

The primary source of repayment for most business loans is the cash flow the business generates. By contrast, personal loans are primarily repaid with cash from individual borrowers (e.g., job income). When reviewing your application for a personal loan, lenders evaluate your credit history, credit score, income and debt-to-income (DTI) ratio.

Many people generate cash flow and spend their money similarly, such as earning W-2 income from an employer and getting financing to buy a home or pay for large purchases. That makes it relatively easy for lenders to use automated processes and tools to analyze the average person’s ability to repay a personal loan.

By contrast, businesses generate cash flow and spend money in different ways. Unless the business size or loan amount is relatively small, humans must manually analyze and review many business loans. As a result, getting a business loan is more time-consuming and difficult than getting a personal loan.

When should I use a personal loan for my business?

You might consider using a personal loan for your business when you’ve exhausted all other financing options, you can easily handle the payment and your credit is good enough for a decent APR. You may not qualify for a business loan if your business is a small startup.

Remember, it’s best to separate your business and personal finances. You need to be able to separately identify and track your business and personal expenses so you can see how much money your business makes and spends. You should only get a personal loan for your business if you plan to use it solely for business purposes.

Also, consider how you’ll generate the cash needed to repay the debt. J. David Bennett, a certified public accountant and founding member of Renaissance CPA Group, said: “Cash flow should consider not only the amount of funds generated, but if the funds generated will match the timing of the required payments. … Borrowing from credit cards with a monthly payment could put a company’s continuing operations ability in jeopardy if [the business uses] the loan proceeds for long-term investments.”

For example, if you’re only generating enough cash flow to make the minimum payments on a credit card, you’ll never be able to pay off the principal balance. You will pay more interest in the long run and fall into a debt trap.

Short-term debt should be used for short-term expenses (e.g., using a credit card to pay for travel expenses). Long-term debt should be used for long-term expenses (e.g., using a loan to purchase a vehicle).

Alternatives to personal loans for businesses

There are many business funding options if you don’t want to use a personal loan. Some of the most common alternatives include:

• Crowdfunding: Crowdfunding raises funds for your business through small investments from a large group of investors. This is a common option for startup companies, since each investor only risks losing a minimal amount of money if the business fails.
• Equipment financing: If you need to buy a vehicle or equipment, many lenders have specific equipment financing programs to help you do so quickly. These loans are similar to a personal auto loan in that you pledge the equipment as collateral and pay the loan back over a period matching the equipment’s useful life (e.g., five years).
• Business credit cards: You can get a credit card specifically to pay for routine business expenses, like travel costs, meals, entertainment and fuel. You can give business credit cards to employees and may even be able to place controls and limits on how they use the cards to protect your business from fraud.
• Business lines of credit: A business line of credit is an excellent option if you need access to money you can borrow and repay repeatedly. While these loans are sometimes unsecured, you may be required to pledge all business assets or your accounts receivable and inventory as collateral.
• Working capital loans: In some situations, you may need financing specifically for your working capital needs, meaning the funds you need to pay your current liabilities and keep your business going. Many lenders offer short-term working capital loans (e.g., for accounts receivable or inventory you can quickly repay) and long-term permanent working capital loans (e.g., for operational business expenses you need to repay over a longer period of time).
• SBA loans: If your business is small or relatively new and can’t qualify for a business loan, you might be eligible for an SBA loan. With an SBA loan, the Small Business Administration guarantees the lender that it will cover a portion of your loan balance if you don’t repay the loan as agreed.

If you don’t know where to begin, a local SCORE business mentor is a great place to start. The SBA offers free business mentoring through its SCORE program to help small-business owners with many aspects of their business, including creating business plans and finding financing.

Bottom line

If you’re struggling to find a way to fund your business, you may be able to use a personal loan to pay for business expenses. Many lenders allow you to use the proceeds from a personal loan for any purpose.

However, using a personal loan for your business can be risky. Even though you got the loan to pay for your business, you’re personally responsible for paying it back. If you don’t repay the loan as agreed, your personal finances and credit score are on the line.

Before turning to a personal loan, there are alternative funding sources you can use to finance your business. Common examples include crowdfunding, business loans from banks and online lenders, business credit cards, business lines of credit and SBA loans. Consult a trusted business advisor if you’re unsure which financing is right for you.