The National Bureau of Economic Research announced in June that the “unprecedented magnitude of the decline in employment and production, and it’s broad reach across the entire economy, warrants the designation of this episode as a recession.” It’s not surprising small businesses have been hit especially hard as a result and are looking for loan options to stay afloat. In the past months, 43% of the businesses had to close their operations to avoid the spread of COVID-19 and meet state regulations. As a result, more than 100,000 established businesses have closed permanently.
Small businesses have resorted to all types of measures to stay afloat: negotiating or deferring fixed costs, such as rent, or trying to access federal aid programs. You may have heard about the Paycheck Protection Program (PPP), a loan afforded to small businesses earlier this year intended to help maintain employees on the payroll. As part of the PPP, the Small Business Administration (SBA) will forgive loans if all employees are kept on the payroll for eight weeks and the money is used for payroll, rent, mortgage interest, or utilities. While the SBA’s launch of the Economic Injury Disaster Loan (EIDL) has helped, the continued uncertainty as to when businesses can fully reopen has made aid insufficient for the needs of small business owners. If you’re looking for ways to keep your small business afloat, whether through a Small Business Loan or Personal Loan, remember that just like with your personal finances, it’s important to consult an expert who can guide you through the best financial decision for the short and long term.
Potential Loans for Keeping Your Small Business Afloat
Many small businesses looking for ways to finance and sustain themselves have reached a difficult fork in the road: to obtain a small business loan or a personal loan. If you’re considering either loan option, ask yourself these three questions:
- How soon do I need the funds?
- How will I use these funds?
- Will these funds affect my personal finances?
The most important question is how the loan may affect the future of your business. Small business loans are inherently different from personal loans, so understanding how they vary is crucial.
What is the Difference Between a Small Business Loan and a Personal Loan?
The most obvious difference is the purpose. Small business loans are typically for a specific use directly related to business operations. Meanwhile, a personal loan is a set amount of money that goes into your personal checking account for free use. As we go into greater detail, you’ll find there are also differences in the application process, requirements, and criteria for receiving each type of loan.
Small Business Loans
The approval process for a business loan takes around three months. It’s important to understand that lenders take into account the economic sector in which the company operates. Some industries are more likely to be rejected for a small business loan depending on the benchmark survival rates for small businesses in a similar industry.
The most common type of small business loan is the commercial term loan. A commercial term loan is granted for a defined period. They vary between short (3-12 months), medium (1-5 years), and long term (5+ years).
Online Installment Loans are offered by online lenders and typically have less stringent requirements, thus making the approval process easier and quicker. The catch is that the Annual Percentage Rate (APR), the money you’ll owe in the long term for that loan, will likely be higher than a commercial term loan.
Commercial lines of credit are similar to personal lines of credit or credit cards. You pay interests on the accumulated credit you utilize, up to the credit limit that’s been set in the terms of your agreement. Commercial lines of credit are often used for cash flow, inventory purchases, or surprise business expenses. The APR on these credit lines can be high, similar to personal credit cards, so make sure to pay off these lines of credit as soon as you can so your interest doesn’t begin to snowball over time.
Merchant Cash Advance (MCA) should be used only as a last resort. MCA costs can be large and payment times short, leading to short and long term problems if not paid off in a timely manner. Merchant Cash Advances deliver an initial sum in exchange for a cut in future transactions, using a percentage of credit card sales until the advance is paid. The initial value and the interest are paid daily or weekly with rates ranging between 1.2 and 1.5.
Invoicing, financing, and invoice discounts are an alternative that can solve problems due to lags in invoice payment times to supplement a company’s liquidity needs. The company can sell its invoices to a third party in exchange for short-term credit. An additional alternative is invoice factoring or Accounts Receivable Financing (ARF). This option is riskier for the lender because control over the invoice collection process resides with the selling company and there is no contact with the debtors. As such, this alternative is offered to companies that already have a proven track record.
Keep in mind that financial products intended specifically for companies and small businesses have the advantage of granting the possibility of accessing tax credits for the payment of interest. Additionally, it will allow you to isolate your personal assets and not put them at risk as it does when taking out a personal loan. While business loans tend to be larger and offer more financing, personal loans may fit your situation if you’re looking for an urgent loan or increased flexibility.
While you can use a personal loan for your business, it’s important to consider the conditions personal loans carry. Unlike business loans, personal loans don’t require specific details on your business but rather are obtained through your credit. The personal loan is in your name, so if you’re unable to repay it in due time you’ll personally face more significant financial impacts, such as a decrease in credit score if the loan isn’t repaid on time. Be thoughtful about increasing your personal debt, particularly during uncertain financial times.
That said, personal loans have the advantage of some increased flexibility. The money you receive on a loan can be used for the most urgent needs of the company, including daily expenses. This can be convenient for companies that have moved their operations to the owners’ homes. Additionally, personal loans tend to have lower annual percentage rates (APRs) than other financial products, such as credit cards.
For some small businesses, it is necessary to have funds available as quickly as possible. As a result, you might defer to a personal loan as business loan requirements can take too long and jeopardize the operation of the business.
If you are considering a personal loan, it is imperative you consult your financial advisor to ensure it doesn’t derail your own finances.
Keeping Your Small Business Afloat
Companies that survive recessions are characterized by their resilience and having a solid financial plan that prevents them from panicking and making hasty decisions. One thing is certain, the current situation demands that you make mindful decisions to ensure your business and financial future: be sure to discuss a potential small business loan or a personal loan with your financial advisor.
Disclosure: This blog is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accounting, tax, legal or financial advisors. The observations of industry trends should not be read as recommendations for stocks or sectors.