Is Starting Your Business with a Personal loan a Good Idea?

For anyone to start a new business, you may need some additional funds. In such a case, most business owners are left with one of three alternatives:

• Borrowing from a friend
• Applying for a Business Loan
• Apply for a Personal Loan

If you too find yourself in the same situation and are wondering which option to go with, read on to understand the nuances of each one of them.

The first option is often the most convenient and easy. Moreover, in most cases, you wouldn’t need to pay any interest. After all, you are borrowing from someone as close as a friend. In fact, you wouldn’t even need to follow a strict equated monthly instalment (EMI) payment schedule. If you have the understanding, you can repay the amount as and when you have the means to do so, on your own accord.

That being said, you may not always have a friend with excess funds. And even if they have some money set aside that they can lend, they may or may not have as much cash as you would need to kick-start or expand your business. For instance, if you are a young entrepreneur, most of your young friends wouldn’t have, say, for example, Rs. 30 Lakhs lying around idle. It is for this very reason that most business owners go for a personal loan or a business loan. Let us understand what these two loans entail, and which of them proves to be a good idea when you wish to start your venture.

Personal Loan

This is one of the most readily available loans in India. All you need is your identity proof, address proof, evidence of your income, and a good credit score (700 or above) to back you, and your personal loan application will get approval in a matter of 1-2 days. The entire loan amount is disbursed at once, and you are entirely free to use the amount for whichever purpose you deem fit. So, when do you opt for Personal Loans? Well, in the below-mentioned situations:

1. When you wish to start your business

A Business Loan offer requires you to furnish proof of registration of the company, its P&L statements, its bank accounts, as well as its Income Tax Returns. Moreover, it needs a credit history. At the very beginning, it may not be possible for you to furnish all of these documents to your bank. It is for this very reason that the best way to convert your idea in an up and running business is by opting for a personal loan.

2. When you have no guarantor

While most business loans are unsecured and do not need any collateral, some banks may require a guarantor to sign off your mortgage. This can help reduce the risk propensity for the bank. However, since your enterprise is in its nascent stages, it may be difficult to find someone with a good credit score to back your Business Loan application. This is yet another reason for you to opt for a Personal Loan instead.

3. When you want a smaller loan amount

When it comes to ready availability, quick approvals and swift loan disbursals, personal loans emerge as the clear winner. Hence, when you need a modest amount ranging anywhere between Rs. 50,000 and Rs. 50 Lakhs, A Business Loan application needs to be attached with a wide array of documents and often takes up to 2-3 months for approval and disbursal of the loan amount. For all you know, a small loan requirement may not be worth the hassle or the wait.

4. When your plan is not chalked out

Banks do not place faith in vague ideas, but in well-laid business plans, complete with financial projections. If your business idea is still in the nascent stages, and you don’t have a stringent plan to take it ahead, a Business Loan application may get rejected. Since the approval of Personal Loan applications is not subject to how the applicant plans to use the money, you may be better off taking this readily available, ‘no questions asked’ credit.

Business Loan

Business Loans are specifically designed for enterprises which are already in existence and generate revenues on a regular basis. It is for this reason that Business Loan applications often need to be accompanied by the proof of registration of business, bank statements, P&L statements, Income Tax Returns statements and audit reports in conjunction with the credit report of the company. Moreover, you need to have a streamlined plan stating how you plan to invest the money, and how much revenue is it expected to generate. Only if everything is in place, and your business plan seems promising enough, does the bank approve the application. This may easily take up to 60 to 90 days of time. Considering the time and effort this loan application takes, it may only be suitable for you in the following cases:

1. When you qualify under CGS

This line of credit can prove to be in your best interest if your business falls in the Micro and Small Enterprise category, and you are eligible under the Credit Guarantee Scheme (CGS). If so, you are entitled to avail loans of up to Rs. 1 Crore, without offering any collateral against the amount. This type of loan can quickly help you meet your working capital needs, or even facilitate the purchase of assets needed to expand your business.

2. When your business enjoys a good credit score

If your business has been in existence for at least one year and has already managed to build a reasonable credit score (750 or above), your chances of getting an approval on your business loan application will become significantly high. Moreover, the loan will attract a highly competitive interest rate, as well as a long tenure, thus making it more cost-effective when compared to a Personal Loan.

3. When you have a loan under your name

In order to apply for a personal loan, it is essential that you are debt-free. If you are already servicing a major credit such as a Home Loan or have outstanding credit card bills, most banks will hesitate from offering you yet another loan. In such a situation it is best that you apply for a Business Loan. That being said, you should be aware of the fact that in some instances, banks take a look at both – the credit history of your business, as well as your personal credit score before approving the application.

Considering the above situations, it is quite clear that for a new business that is yet to be established, a personal loan would work much better! On the other hand, when the loan requirement is exceptionally high, or when you wish to enjoy longer repayment tenure, it may be in your favour to opt for a business loan.