Whilst startups with lofty goals and extensive business plans have a good chance of securing venture capital or angel investments, this isn’t always the case. Founders sometimes are faced with – or prefer – not receiving funding to avoid losing their share capital.
Instead, they look for alternative ways to fund their nascent business venture personally in the initial stages. Ultimately, they may not look to expand beyond what self-funding and internal growth permit, even as many startups wrestle with how to manage their workforce through the pandemic. However, many founders do see the advantage of borrowing – rather than exchanging equity – because this is preferable to them.
In this article, we look at two ways of getting some additional money outside of traditional business avenues or exchanging capital to do so.
Personal loans are either secured or unsecured
A personal loan is one that’s lent to individuals, not directly to startups or other types of businesses.
They’re commonly used for a variety of reasons including personal spending, a new automobile, to travel or for home improvements.
Personal loans come as two distinct types – secured and unsecured.
An unsecured personal loan is issued in the borrower’s name. Nothing is backing it like collateral such as a savings account balance, share certificates, or something else.
The second type of personal loan is a secured one. This includes agreed-upon collateral that provides security. These loans are safer for the lender because the borrower has pledged something of value against the loan that’s being sought.
Secured personal Loans
Personal loans that include collateral are called a secured personal loan.
The idea with collateral is that the lender has the option to take possession of it and sell it at the value they agreed with the buyer, with the proceeds going towards the outstanding balance on the lending facility.
With collateral, the risk of issuing the loan is significantly lower for the lender. This affects these loans in two distinct ways:
- Lower interest rates compared to unsecured personal loans
- Increased likelihood of loan approval
Now, it’s important to be aware that lenders require different types of collateral. They may also vary in their decision about what percentage of the loan value must be covered by the security that’s being offered.
To find the right lender, it’s best to review the best-secured loans currently available. This allows you to locate one that accepts the type of collateral that you wish to pledge as your security.
Unsecured personal loans
For some founders, they feel uncomfortable raising funds by issuing more shares or putting down collateral. It may seem like an overly complicated way to raise money to put into a new business venture and you wish to avoid doing it.
Fortunately, there’s also the option to borrow money using an unsecured personal loan. The money is lent on your name and you’re responsible for meeting all the repayments on time. Because there isn’t any security provided in support of the loan, in the event of getting behind on payments, the lender would chase up repayment directly with you.
While you can look for the best deal online, all things being equal, an unsecured loan has a higher APR interest rate than a secured loan. This is because they are riskier for the lender, so the increased interest rate reflects that.
Which loan is best for a business founder?
It depends on which type you prefer.
If providing security will cause you to lose sleep, then an unsecured personal loan is probably the better option for you. On the other hand, some founders are more comfortable providing security because they feel it is the right thing to do and they are less stressed about doing so – managing stress as a startup founder is an article in itself.
Due to these considerations, it doesn’t always come down to which loan is the least expensive type. You’ll live with the loan for the full term – perhaps, 12 to 36 months – and so it’s best to be happy with your choice.
Is funding a business using loan a sensible decision?
This is a valid question to ask. However, again, it’s a personal thing. It’s certainly true that venture capitalists with successive rounds of funding can end up owning a significant chunk of your business. If you’re looking to become financially independent through the eventual sale of the company, then it will need to be substantially more successful to command the right price.
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The reality is the value of the equity given away to early investors is hugely expensive later for startup founders. It can a source of some regret later. Whereas taking out a loan of whatever type leaves you will the responsibility to repay it, but you do retain more (or all) of the equity in the business.