Something like 90% of small businesses fail. That’s a pretty pathetic statistic.
I know this is a personal finance website, but (surprisingly?) small business loans are a personal finance issue. Let me explain.
Business Debt = Personal Debt
I’ve heard it too many times, “My only debt is a little bit of business debt, but that won’t affect anything."
If only that were true! It turns out that business debt is personal debt unless you’re on the fortune five hundred list.
No, your blog isn’t a fortune five hundred company; neither is your contracting business. I don’t care that it’s an LLC; it’s still not separate from you.
Lenders aren’t stupid. They know that selling the assets in your business won’t cover the costs of most small business loans. So they won’t take it as collateral. Instead, they’ll make your personal assets (your house, car, etc) collateral for the loan.
So the first thing you need to understand is that business debt is personal debt. It’s on your credit report and it’s going to follow you no matter what happens to your business. You signed on the loan and you (not your business) are responsible for it
Why It’s A Bad Idea
So why is it such a bad idea to take out personal loans on a business? I’m glad you asked!
First, it starts you in the negative. When you pay cash to start a business you’re able to start day one at $0. That means you can profit from your first sale without any issues. The money you spent to start the business is called sunk costs and it stops counting after you’ve spent it.
Debt, on the other hand, stays with you. When you take out a $30,000 dollar small business loan you’ve got to earn a $30,000 dollar before you can make a profit. Not fun.
Second, it increases your risk. Starting a small business is risky enough. Remember that $30,000 dollar loan? If you can’t make enough money to pay for it, you’ll have to find the money from your own pocket. That may mean finding another job, losing your house, or closing your business to earn enough money somewhere else. The risk involved is huge!
With cash, there isn’t as much risk. When something goes wrong or money gets tights you don’t have to worry about a huge debt payment hanging over your head. You can make more mistakes and recover more quickly.
Third, it isn’t necessary. With the internet, the playing field has changed. Advertising is free through social media. Developing and launching a website can be done for under $100 dollars. It’s no longer necessary to have tens or hundreds of thousands of dollars to get your business off the ground. Maybe the old guard still needs that stuff, but your business can thrive without the weight of debt or huge start up costs.
Starting a business is hard enough without debt hanging around your neck. Your business needs the freedom to have problems, to make mistakes, and to develop into something successful. Debt may seem like a good idea at first, but when you consider the liability it adds to your family and the risks and limitations it adds to your career, it doesn’t end up being worth it.
Alex Humphrey is a personal finance writer and coach at EntrepreLife a personal finance blog that teaches easy ways to dominate money by dropping debt, investing well, and saving for the things you love to do. When he’s not blogging he leads a youth group, spends time with his wife, and figures out new ways to teach people personal finances. You can follow him on Twitter and Facebook and subscribe to the EntrepreLife mailing list.