Business Loan vs. Personal Loan: What’s the Difference?
Whether you bootstrap a new business or plan to buy an existing one, most business owners need a loan at some point on their entrepreneurial journey. For aspiring entrepreneurs, purchasing an established business can offer a smooth entry into small business ownership, often with existing cash flow and clientele.
Loans serve many purposes, but the question is, should you get a business loan or a personal loan, and what’s the difference?
What Is a Business Loan?
A business loan is a type of financing specifically for businesses. Its purpose is to fund new opportunities, help your company grow, or cover business expenses. Unlike a personal loan that you can use at your discretion, you must use a business loan exclusively for business purposes.
Pros of Business Loans
Business loans offer several advantages that can help your business thrive, especially for small business owners looking to expand, launch, or acquire existing businesses.
- Larger Loan Amounts: Business financing typically offers more financing than personal loans.
- Business Credit: Paying off a business loan can help build your business's credit and make it easier to borrow in the future.
- Different Loan Options: Thanks to diverse options for business loans, you'll likely find one that fits your specific business needs, whether for short-term cash flow or long-term growth.
Cons of Business Loans
While business loans have many benefits, they do come with some challenges.
- Harder to Qualify: Business loans often have stricter eligibility criteria. Lenders may look for a solid business plan, financial records, and business credit history. Some may even ask for a personal guarantee, which means you have personal liability if the business can't repay the loan.
- Take Longer to Get: The business financing process can be lengthy, sometimes taking weeks or months for approval and disbursement of the loan funds.
- Strict Repayment Terms: Prepare to stick to the agreed loan terms, as business loans typically have more stringent repayment periods.
Types of Business Loans
From unsecured and secured loans to a business line of credit, there are many financing options for small business owners and large enterprises that match their business needs. Knowing the different loan options can help you with the application process, as qualification requirements may differ.
Some of the more common business loans include:
- Working Capital Loans: These loans help borrowers manage day-to-day expenses like paying employees, rent, or utilities. They're ideal for maintaining smooth operations when cash flow is tight.
- Operating Expenses Loans: These cover basic business costs, like supplies or overhead. You may need this type of loan during slow periods when income dips, but expenses remain unchanged.
- Acquisition Funding: If you're buying another business, acquisition funding provides the capital you need for the purchase. These loans tend to be larger.
- SBA Loans: The Small Business Administration (SBA) offers loans with government backing, which can help businesses that might not qualify for traditional loans. These small business loans often have lower interest rates and better terms, but they also require more paperwork and take longer to process.
What Is a Personal Loan?
A personal loan is money borrowed from a bank or lender for any purpose. Some typical uses include paying off credit card debt, financing real estate, or debt consolidation.
Personal loans are typically for individual use. But, many people use them for business needs, especially if they don't qualify for a business loan.
Using a Personal Loan for Business Needs
Some small business owners, especially startups, turn to personal loans for quick funding.
A personal loan for business use can make it more challenging to separate business expenses and personal finances, but it's a viable option if your company has a thin credit history or doesn’t qualify for a traditional business loan.
Pros of Personal Loans for Business
- Greater Flexibility: One of the biggest advantages of personal loans is their flexibility. There are no restrictions on how a personal loan is used. This can be helpful if your business needs immediate cash for equipment financing, launching a project, or an unexpected expense.
- Quick Approval Process: Personal loans usually have fewer requirements than business loans, and you won't need to provide detailed business plans or financial statements. This can make it easier and faster to get approved.
- Fast Funding: Once approved, borrowers often receive a lump sum within a few days.
Cons of Personal Loans for Business
- Shorter Repayment Terms: Personal loans often have shorter repayment terms and lower loan amounts than business loans. This means you might not get all the money you need, and you'll have to pay it back faster with potentially higher monthly payments.
- Higher Interest Rates: Personal loan interest rates are typically higher than business loan rates, resulting in higher overall payments.
- Don't Help Build Business Credit: Personal loans only affect your personal credit score and don't help build your business credit score.
Which Loan Type Is Better for Business?
Where you are in your entrepreneurial journey will influence the type of loan that’s better for your business. It will depend on several factors, including your goals, financial situation, how quickly you need funds, and whether you're starting a business from the ground up or acquiring an existing business.
Which Loan Is Better for Entrepreneurs Through Acquisition?
For Entrepreneurs Through Acquisitions (ETA) conducting a self-funded search, personal and business loans can play a role in your strategy.
Personal loans can be a good fit for smaller acquisitions or for funding the search process itself, especially when you need quick, flexible funding without the hassle of extensive documentation.
On the other hand, business loans are more suitable for larger acquisitions where more capital is needed. They also provide the added benefit of building business credit, which can be critical for future growth and expansion.
Many ETA entrepreneurs start with a personal loan during the self-funded search phase. Once they secure a business, they transition to business loans for acquisition funding and future growth.
Understanding the trade-offs between each type of loan is essential to making the right choice based on your specific business needs and financial situation.
Choosing a Personal Loan vs. Business Loan Based on Business Objectives
Your business needs are the biggest factor in helping you decide between a personal loan and a business loan.
If you want to make a large investment or grow your business, a business loan is usually the better option because it offers better financing and longer repayment terms.
Alternatively, if you need quick cash for smaller expenses, a personal loan might be easier and faster to get.
However, the decision is often beyond your control. Lenders’ assessment criteria may not align with your business goals. Many use the Debt Service Coverage Ratio (DSCR) for business loans, which examines how well your business's cash flow can cover its debts. For personal loans, they examine your Debt-to-Income Ratio (DTI) to compare your monthly income to your debt payments.
If your business is cyclical, many lenders will review your business’s annual cash flow to get a more accurate picture. This can help ensure you choose a loan with repayment terms that work for your company throughout all its cycles.
In all instances, lenders want to feel confident that you manage money well and will repay any money they loan you.
Eligibility criteria and application processes for both loan types
Eligibility for personal loans versus business loans vary overall, as we’ve mentioned, in application requirements, approval times, and loan terms. But beyond that, different loan types within each have specific eligibility requirements and process, which may also vary by lender.
As funding is a critical aspect to your business, it’s a good opportunity to consult your support network and mentors, from business and industry sources to business brokers and accountants. They can help guide you as insiders in the area and experienced professionals, allowing you more time to focus on your business rather than navigating the financial seas alone.
If you need assistance with financing a business acquisition, to explore BizBuySell’s Learning Center or our Finance Center. These resources are designed to help you with financing your business purchase or pre-qualifying your business for sale.