Updated on 03/12/2020
As a small business owner looking to finance your business, you may be thinking about turning to a loan to provide the funds you need to help your business grow, or maintain its current operations. Whether that involves boosting your cash flow or financing an expansion, you may want to understand the range of options available to you.
While we’ve covered the ins and outs of business loans in our SME guide, in this article we’re going to answer a commonly asked question; should you be looking for a business loan or a personal loan?
To answer this question properly, we’re going to take a look at the difference between business and personal finance, and identify how you may want to make a decision based on your situation. We’ll also share some tips on what to look out for when assessing your options.
The short answer is ‘generally, no’; personal finance should be used for personal needs, while business finance should be used for business needs. That’s not to say that it’s literally impossible to use a personal loan to finance a business pursuit- a few lenders may allow it, but for the vast majority of SMEs this is not the best option.
The terms and conditions set by a lender when you sign a loan agreement are likely to specify the purposes for which you can actually use that money, so be sure to read these thoroughly and ask any questions you have to a lender before making an agreement.
Ideally, you’ll know exactly how you want to use a loan to empower your business before taking it out. It’s common practice for lenders to ask you to explain your financial plan to some extent- which could help them build confidence in you and your vision.
‘Personal loan’ and ‘business loan’ can represent entire categories of loans. We’ve compiled a guide on the different types of business loans that are widely used in today’s market, including an overview of those uses which can range from growing teams and buying assets to purchasing stock quickly to meet large orders.
There’s an equally comprehensive range of options and uses for personal loans, which typically involve making renovations to a domestic property, student finances, or meeting outstanding bills. While the basic premise of a loan is the same, the two should always be kept separate.
The risk in personal finance is slightly different to business finance. For example, if you were to start a business using your own personal finance or loan and the business was unsuccessful, you would be exposing your personal assets on behalf of the business.
Conversely, if you have registered a limited company and taken a loan out in the name of that company, the company itself would be liable for its debts. This may not seem like a huge distinction at first, after all, you’re still going to have to find the money to pay off a business loan, but there are legal differences between personal liabilities and business liabilities.
Some more granular differences between business and personal loans include:
From an eligibility perspective, you’ll need to either own a business or be in the process of starting up a business to qualify for a business loan. As well as this, lenders will often have additional eligibility requirements to qualify for the loan which takes into account your business’ history (and particularly its financial history).
Personal loans could have less eligibility requirements tagged onto them than business loans, as they will usually only take into account your credit history and your personal income in order to determine the rate you’re offered. Less eligibility criteria isn’t necessarily a good thing, though, as business loan lenders will often work with you to build an understanding of your goals and objectives, which could influence their judgement on your application.
The interest rates you’re likely to be offered on loans is dependent on whether you’re applying for a secured or unsecured loan. Lenders typically want to be confident in their investments and lend you a reasonable amount of money that enables you to accomplish your goals while still maintaining their faith that you’ll be able to meet your scheduled loan repayments.
Small business loans can sometimes offer better interest rates, given that the loan application process is often more thorough than the equivalent personal loan application process, sometimes even including an examination of your personal financial history and credit history. This could mean that the lenders feel they are taking less risk by offering you a loan, and subsequently they may offer more competitive interest rates.
There may also be more flexible repayment periods associated with business loans, especially in peer-to-peer lending, however this can differ from lender to lender so be sure to examine the loan conditions before making an agreement.
Also, if your business is positioned well to succeed and grow quickly moving forward, you may find that the lending ceiling for business loan offers is much higher than a personal loan offer is likely to reach. After all, a business has opportunities to continually grow; acquiring new staff, generating new income streams and diversifying its offering at, often, a larger scale than the majority of individuals are capable of.
Although it may seem like business loans are slightly more complex, the application process can be equally as simple. At Esme, for example, we’ve worked hard to make our loan application process paperless, simple, and as stress-free as possible.
If you have a poor credit history, your loan or finance applications can often be impacted as a result. This can be frustrating for new businesses, but the result very much depends on individual circumstances, so it shouldn’t stop you from applying for a business loan. If you are a new business without a business account or with poor credit, lenders may look at your personal credit history to see how much of a risk you could pose to the lender.
The majority of software associated with personal and business finance is related to accountancy, and the management of funds flowing through your bank accounts. Perhaps the best-known example of this software beyond banking or lender’s own software is cash flow apps.
These apps may help individuals or SMEs keep an eye on cash that is flowing into and out of the business. They may also help to provide insights into the bigger picture of your business’ cash flow; helping you to identify potential problems and patterns by crunching large heaps of data. These insights, in turn, could help you make more informed high-level decisions about your product/service offering, operations and supply chain requirements.
Other software examples could include bookkeeping software, software that helps with managing and sending invoices, or even time tracking software.