Finance 5 July 2018

A micro business guide to choosing between personal and business finance

A majority of small business owners now expect to be rejected for finance

Almost every small business needs to borrow at one time or another. However, since the financial crash of 2008 banks have significantly tightened their lending criteria, making them very reluctant to agree businesses loans without a track record.

So, when you’re starting out and struggling to raise money, it may be tempting to borrow as an individual. But what are the advantages and drawbacks? Carl Faulds, managing director at Cashsolv, answers these questions for you.

What’s the difference between personal and business finance?

Whilst it’s theoretically possible to use almost any loan for almost any purpose, most lenders offer targeted financial solutions to different customer groups. For personal borrowers, there are loans and overdrafts; business customers can also choose a business line of credit, merchant cash advance, or invoice factoring or discounting.

However, the biggest difference is liability. If your limited company can’t pay back a business loan and becomes insolvent, you won’t end up on the hook for its debts unless you were trading fraudulently or negligently.

However, if you borrow as an individual (or give a personal guarantee on a business loan, which amounts to the same thing), you will have to make up the shortfall and could end up homeless.

There’s a second major drawback to taking a personal loan: the amount you can borrow. In general, business loans can be obtained for anything up to 10 or even 100 times the limit for a personal loan. But that’s for established businesses with a good credit rating.

If you don’t fall into that category, a personal loan could remain your only option.

How are personal and business loans approved?

When you apply for a personal loan, the lender will consider your income and outgoings (i.e. your ability to repay) and your credit score (i.e. the likelihood that you will repay). If you’re seeking a realistic amount of money and have a strong credit score, everything should be plain sailing.

Business loans operate slightly differently. Corporate income, outgoings and credit score are still very important factors, particularly if you’re borrowing from a bank. However, your business plan, profitability to date, cash flow and track record as an individual will also be factors.

Alternative lenders are generally more willing to deal with companies with a compromised credit history and tend to place more emphasis on your business plan and prospects.

When is a personal loan a better bet?

Put simply, when you can’t get a business loan.

It’s hard to be more nuanced, but the risks of taking a personal loan are substantial and the results of defaulting can be catastrophic. In general, mixing your personal and business finances is a very bad idea.

Not only do you lose the legal protection of operating a limited company, but you’ll also create a messy and complicated accounting history.

What happens if my bank won’t extend a business loan?

Banks are inherently (and often rightly) cautious about lending to startups. In this situation, taking a personal loan is certainly an option. You don’t get anywhere in business without taking a few risks.

However, before you put your house on the line you should get on the line to some alternative lenders to see what they can offer.

What other forms can business finance take?

There are quite a number of ways that you can borrow. An obvious answer is a structured business loan, in which you borrow an agreed amount and repay it over a fixed period.

These loans can be unsecured, secured on a business asset or backed by a personal guarantee. As already discussed, the latter strategy is risky, though it can sometimes result in a much lower interest rate.

Another option is a business line of credit. This acts like an overdraft. You agree a credit limit with the lender and can then borrow or repay at will. Lines of credit tend to attract much higher interest rates than loans, but their flexibility is unrivalled and of course you only pay interest when you’re actually using the facility.

Alternatively, you could opt for a merchant cash advance, which allows you to borrow an agreed sum and repay it via a fixed percentage of your daily credit card sales.

The advantage is obvious: you’ll never have to make a fixed monthly repayment during a quiet period. This can be a lifesaver if you operate a business with a seasonal turnover. The drawback? The cost tends to be astronomical compared to a structured loan.

If you’re borrowing to boost your cash flow rather than to power growth, invoice factoring or discounting could be exactly what you need.

These innovative solutions can tame a troublesome cash flow forever by enabling you to borrow against your invoices the instant you issue them. Lenders’ limits vary, but you’ll typically be able to take around 85%. As the name “invoice discounting” suggests, the finance company will take a proportion of the remainder for providing the service.

The difference between them? With factoring, the finance company will assign experienced credit control professionals to secure early repayment, thus minimising your interest charges, whilst with invoice discounting you retain control of your own debtor ledger.

The former is ideal for small companies without a dedicated accounts receivable function, outsourcing the entire process, whilst larger businesses may prefer not to have their customers dealing with a third party.

If you can get a business loan, do. If you can’t, consider personal finance

As can be seen, business finance is by far the better option.

You can borrow a lot more, with a wider range of flexible options, and with far less serious repercussions. But if you’re a brand new startup and can’t obtain business finance, a personal loan may be your only option. Only you can decide whether it’s worth the risk.

Carl Faulds is managing director at Cashsolv

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