Should You Use a Personal Loan to Fund Your Business?

If you want to launch or grow a business but can’t seem to qualify for a small business loan, a personal loan could be an appealing alternative. While they may not offer the large maximum loan amounts that small business loans do, personal loans are easier to qualify for and require less extensive documentation. That could be particularly attractive to owners of new businesses.

“In general, the best time to get a personal loan is when you’re just starting a business and are unable to qualify for other types of financing,” says Priyanka Prakash, senior staff writer at small business marketplace Fundera. “Sometimes it’s hard for startups to qualify for business loans without showing a stream of business revenue, and in that case, a personal loan can be a good option.”

Here’s a look at the pros and cons of using a personal loan to fund your startup or expand an existing business. Understanding both sides can help you decide whether it’s the right move.

Pros of Using a Personal Loan to Fund a Business

Applying for a personal loan is faster and easier. Generally, a personal loan is made to a person, not a business, but for business owners who need fast access to capital, it could be a good option. “Personal loans require less documentation, and the loan decision is quicker,” says Paola Garcia, vice president at Excelsior Growth Fund, a nonprofit small business lender serving New York, New Jersey and Pennsylvania.

In addition to basic personal information – like your address, date of birth, income and Social Security number – you’ll have to provide a few supporting documents, such as a recent bank statement, pay stub or federal W-2 form. Prakash says, “Be prepared to show a steady income stream from a day job or that you have enough personal assets or savings to pay back a personal loan.”

Depending on the lender, you may be able to get personal loan funds in a matter of days.

Applying for a small business loan is a little more involved. Bernardo Martinez, U.S. managing director at Funding Circle, an online business loan platform, says, “Business underwriters will consider your business’s entire financial picture, not just your personal credit profile. They’ll look at factors such as the business’s cash flow and collateral, which don’t get considered during a personal loan approval process.”

You may also have to report the number of years you’ve been in business, your monthly and annual revenues, and your business credit scores, in addition to your personal information. In terms of documentation, you may need to show the lender cash flow statements, a profit and loss statement, business bank account statements, tax returns and a balance sheet. Getting those various documents together can make applying for a business loan much more time-intensive.

Small business loans don’t always provide a lump sum. Instead, you might have to submit a draw request to have the loan proceeds disbursed to you periodically. To do that, you may have to show invoices, receipts or a project budget documenting what the money will be used for. With a personal loan, you would be able to receive access to the lump sum.

Cons of Using a Personal Loan to Fund a Business

Taking out a personal loan for your business can negatively affect your personal finances. Even though you’re using the loan for your company, the debt is still in your name. Lenders may be less inclined to extend you credit or loans if it looks like you have a lot of debt.

Also, if you take out a personal loan and your business isn’t generating enough revenue to allow you to repay it, your credit score could suffer. Even one late or missed payment can cause your credit score to drop as much as 100 points. Of course, the same could happen if you sign a personal guarantee for a small business loan.

You might be able to borrow more with a small business loan. “Business loans are designed for businesses,” Martinez says. “They’re available for larger dollar amounts, which allows you to make an additional investment in your company and potentially grow.”

Small business loans may have maximum loan amounts as high as $1 million, while personal loans typically don’t go higher than $100,000. Depending on the lender you choose and how much your business can qualify for, a small business loan may offer much more leeway for funding larger-scale projects.

Martinez says having a larger financial need than a personal loan can satisfy is a positive thing, as “it means you’ve evolved from an entrepreneur with a good idea to a true business owner scaling a company.”

Personal loans don’t help you build your business credit score. For that, you’ll need to have loans, credit cards or other credit accounts registered to your business’s name and identification number. Having accounts with a positive history on your business credit report can make it easier to qualify for small business loans, secure the best interest rates on financing and potentially qualify for lower business insurance premiums.

What to Consider When Applying for Personal Loans for Your Business

Personal loans are available at a range of institutions, including large banks, credit unions and online lenders. As you shop around, remember that different lenders can have different rules regarding the use of personal loan funds for business purposes. Discover, for example, allows personal loans to be used for business, while SoFi, an online lender offering unsecured personal loans, does not.

When you’re comparing loan offers, consider:

It’s a good idea to check your personal credit report and score before you apply. This can give you a better sense of which loans you’re more likely to qualify for. Borrowers with poor or fair credit scores may have a better chance of qualifying for a loan with online lenders. Just keep in mind, however, that a lower credit score may translate to a higher APR, as the best interest rates may be reserved for borrowers with good to excellent credit.

Also, estimate what you think you’ll need for your business. Ideally, you should borrow no more than what you need to minimize interest charges over the life of the loan.

Getting a personal loan from friends or family may be the easiest to qualify for and offer the best terms overall. “If your family and friends believe in your business idea, they might want to help,” Garcia says. But there’s one very important downside to consider. “If you can’t pay back the money, you risk putting a strain on the relationship or even worse, losing it completely,” she says.

Personal Loans Are Just One Option

One final note about using personal loans to fund a business: It’s not the only choice available. As you canvass different financing methods, take time to consider the pros and cons of these alternatives: