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Business Loan vs Personal Loan: Which Is Better for Small Business?

India has the third largest number of start-ups in the world. We have great entrepreneurial energy and passion. Access to affordable capital is critical for small businesses to thrive and grow to generate enough operating income to sustain by themselves.

The government has been playing a role with the launch of schemes such as Mudra loans wherein it has disbursed Rs 6 lakh crore to 12 crore people since its launch in April 2015.

However, there is still a lot of dilemma among young entrepreneurs who are often confused about opting for a business loan over personal loan. While we cannot have a correct answer to this, a good evaluation with the context and life stage of the business could enable young entrepreneurs to take an informed decision.

Let’s delve a bit more into this and analyze when the choice would, or rather should, veer towards a new business loan:

Interest Rates:

Personal loans are a product that is created by financial institutions to cater to one’s personal needs such as a wedding, home improvement, or some urgent cash requirement. The interest rates are normally high. Entrepreneurs who opt for personal loans as against applying for a business loans will incur an increase in cost of funds which does not help a newly incorporated business.

Shorter Tenure:

A personal loan normally has a shorter repayment tenure compared to a business loan. This means that entrepreneurs will have to pay out more money in terms of EMI per month. This impact on the cash flow is not a favourable one for businesses that have been actively operational for a very little time.

Terms of Future Lending:

If an entrepreneur is funding his business through personal loans, the interest is high and so are the EMI pay-outs. The probability of a default and cash flow problems are much higher. In such a case, it becomes extremely difficult for the business owner to establish credibility and get attractive lending terms for future loans. Should new entrepreneurs apply for a business loan to ensure credibility for their businesses if nothing more?

Use of Funds for personal expenses:

As it is a personal loan, business owners may use it for an emergency personal need. This leads to a lack of discipline and mis-apportionment of existing funds towards initiatives that will not help to drive business growth. A business loan can enable entrepreneurs to circumvent such problems.

Leveraging benefits of Government Schemes for Business:

If the business qualifies for the credit guarantee scheme of the government, the business owner can get collateral-free loans of up to Rs. 1 Crore. In such a case, a business loan of such a high quantum at a better interest rate augurs well for the business compared to a personal loan. Meanwhile, a personal loan of Rs. 1 Crore without collateral backing would be a tall ask for anyone who is just starting his business.

While you can get a personal loan instantly if you fulfill the basic eligibility criteria or by just walking into your nearest ATM, it may, at best, address an emergency business need. It is not advisable as a practice to take a personal loan to expand your business. Astute entrepreneurs would apply for a business loan instead!

Amount and urgency of the loan requirement:

Both are critical factors which can influence the decision of opting for business loan over personal loan. If the amount of the loan required is too high but the business has been doing well over the last few years, the chances of obtaining a business loan at favourable rates of interest is higher. As for the urgency of the requirement, a personal loan may be sanctioned faster than a business loan.

However, the personal loan amount sanctioned will be lesser in case the business owner has an existing personal loan, home loan, vehicle loan etc.

What’s better?

Is your business in the incubation phase? Has it started generating revenues? Has it started generating recurring cash flows? All these questions are significant to address the quantum of new business loan that can get sanctioned.

Business may require loans to manage working capital, expand presence and infrastructure, import systems and equipment, and so on. The amount required for such loans is substantial and it is in the interest of the business to ensure that the cost of raising capital is feasible and affordable. Hence, business loans are better equipped to fund the growth of an enterprise as compared to personal loans.

Unless an entrepreneur is just starting out and is in no position to use personal savings, or raise seed capital, business loans will give entrepreneurs a better chance to ensure sustainable growth of their enterprise.

If you are an entrepreneur who nurtures the ambition of creating a great business and an everlasting brand, it might be prudent to apply for a business loan instead of opting for a personal loan for business growth.

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