Should You Pursue a Business Startup Loan From a Private Lender? 5 Outstanding Points to Consider

A business startup loan is a necessary evil in any entrepreneur’s arsenal. It can serve as a lifeline when you need cash to buy essential assets or establish working capital to fund your operations until they become self-sustaining.

Unfortunately, business loans have become one of the most unpopular financing options for entrepreneurs particularly those coming from a private lender.

There are multiple reasons for this, from an increased awareness of the dangers of high-risk lending to an increase in regulatory requirements that make them harder to get.

You can read more about other alternative financing options in this blog post.

However, it doesn’t mean that you should abandon hope just yet! You just need to understand how these factors affect your particular situation and adapt your borrowing strategy accordingly so that you don’t put your business at risk.

Let us first properly define a business startup loan for you.

What the heck is a business startup loan?

A business loan is a debt instrument that a borrower uses to obtain capital from a lender to fund a business project. You typically apply for a business loan from a lender who, instead of investing their own money, simply gives you control over a portion of their assets, and you return it when you repay the loan.

Since you’re not putting any of your own funds at risk, you can get a loan for any business project and the lender won’t demand collateral. There are two main types of business loans: long-term loans (of one to five years) and short-term loans (of one to six months).

Only small enterprises and startups are eligible for business startup loans. They normally also offer more alluring terms and lenient penalties for organizations that are just starting to navigate their financial needs.

Finding debt finance can be done in a variety of ways. Banks, financial institutions, and investment firms that deal in debt financing can be contacted. Additionally, you can hunt for online lenders online.

Here you can see various sources of private and non-private loans in the US and other countries.

Below we discuss five essential points to consider before committing to a business startup loan from a private lender.

1. Are you sure you need a loan?

Yes and no. Many entrepreneurs are under the impression that they need a loan to start a business. This is not true. You can easily start a business with your own money. The lean startup approach exactly addresses this issue.

You can read a summary of this approach and how you can use it to successfully raise capital in this blog post.

However, funds to grow your operations and expand your reach come from two sources: You can raise cash from investors, who put money into your company, who receive equity in your business as a reward for their money.

Or you can use debt financing, which is borrowing money from a bank or other lender, who receives a percent interest on your business as a reward for loaning you the money. However, the only way to start a business that requires a loan is to get a loan.

If you have exhausted other financing options, then a business startup loan should be something you consider. Otherwise, depending on your future plans and whether you are willing to give up equity or not, you can consider a business loan.

2. Is your company creditworthy?

You can easily check if your company is creditworthy by using a credit check service, such as Credit Karma or Credit Sesame. These services will show you if your company’s financial statements are accurate and if your financial information is fully and accurately reflected in your loan application.

If you discover any inaccuracies or incomplete information in your loan application, the lender will likely reject your loan application. This is a very important factor that you need to consider before taking out a business loan.

If your company does not have a good credit score, it will make it harder for you to get financing from commercial lenders. On the other hand, if a lender sees a high credit score for your company in a credit check service, it will be easier for you to borrow money from that lender.

Another point is that if you can’t show that you have the funds to pay for the debt, you can’t use a loan to help fund your business. This is a critical component of any financing strategy, but it’s especially important when borrowing from a private lender.

With that said, you can still get a business loan even if your credit score isn’t perfect. You just need to demonstrate that you can repay the loans you currently have and show the lender that you are capable of repaying the loan you’re applying for.

3. Do you know how to choose and approach the right private lender?

Given the high risks associated with high-risk lending, most lenders are reluctant to provide loans to small businesses.

This leaves you with two options when looking for a private lender: You can go with the first lender that offers a business loan or loan with minimal requirements. But the first lender may reject your loan application, leaving you with no loan.

Alternatively, you can look for a carefully screened and pre-vetted private lender that’s willing to work with small businesses. The first thing you should do is conduct thorough due diligence on different lenders.

Keep in mind that private lenders are not regulated in any way. As such, you have no guarantee that they will be careful with your money. If you choose the wrong kind of private lender, you risk losing the entire amount of your loan.

Before you can apply for a business loan, you usually have to satisfy certain loan approval requirements. Usually, lenders will want you to generate a business plan, calculate the expected revenue from the loan, present financial statements, and other documentation.

Once you’ve satisfied these requirements and you’re approved for a loan, you’ll need to negotiate the terms of the loan with the lender before signing the final loan documents.

4. Do you know how the lending process works?

Private lenders will first evaluate your financial documents and your credit score before deciding whether to offer you a loan. If they decide to offer you a loan, they will put the loan amount down as a deposit with your lender.

The transaction between the two people is done through email or in-person whenever the lender and the borrower desire. Private lenders usually charge a fee for each loan they offer. Some will charge a flat fee, while others will charge a percentage of the loan amount.

You need to remember that these fees are not taxes. They are a fee that the lender charges to cover their expenses including the administrative work of processing loans.

There are two main business lending models: asset-based lending and business debt.

• Asset-based lending: With this model, the lender lends you money based on the value of the assets you pledge as collateral against your loan. The loan amount, repayment schedule, and interest rate are determined by the lender and are usually disclosed in the loan documents.
• Business debt: In this model, the lender loans you money based on an agreement that states that you’ll repay the loan in accordance with the terms and conditions stated in the loan documents.

5. Do you know the downsides of taking out a loan from a private lender?

One of the biggest challenges that entrepreneurs face when looking to take out a private loan is finding a lender that will offer the loan amount they need. Because these lenders have no formal control over who they loan money to, they generally only offer loans to those with strong credit scores. This means that borrowers with less-than-ideal credit scores have little chance of getting a loan.

In addition, private lenders usually require that you have a pre-existing relationship with them in the form of a business loan. This means that they are likely to ask you to repay your current lender before they will let you borrow any money. This can make it difficult to get a loan to start a new business.

Many private lenders are high-risk and high-cost. Commercial lenders often require a good credit score to get approved for loans, while some private lenders have no credit score requirement at all.

You should also be aware that private lenders charge higher interest rates than commercial banks. These rates may be high enough to put you out of business if you miss a payment.

Bottom Line

Private lenders are a necessary evil for entrepreneurs who need quick cash. They can provide a lot of flexibility, but they are not regulated and are therefore much more risky than traditional loans.

It is important to understand the risks associated to taking out a private loan. If the opportunity outweighs the risks, it can be an effective way to fund your business.

Otherwise, we suggest you to consider other types of external funding or business startup loans in your networks due to their advantages over private lenders.