Most home-based businesses operate as sole proprietorships, and there are numerous advantages to running your business this way. Being a sole proprietor means you can count on full ownership of profits, swift formation, easier management, and a simpler tax process. The challenge with sole proprietorship, however, is that securing financing to grow your business can be tricky.
Fortunately, there are more options than ever before for sole proprietors looking to expand their operations. Before you begin researching options, though, take some time to carefully review your finances.
Look at your regular business expenses, profit and loss statements, debts and assets, and current cash flow situation to figure out how much money you have coming into your business, as well as what you’ll need going forward. It’s important to determine whether you’ll be able to handle future loan payments or cover any losses your business may incur. Ultimately, getting a better understanding of your financials will help you decide which type of loan to go for.
To help you find the best financing solution, we’re exploring two common types of financing for sole proprietors: personal loans and business loans.
Personal loans
The requirements for personal loans and business loans can be similar, but personal loans are often easier for sole proprietors to obtain, since they don’t usually require collateral to secure the loan, nor is there much paperwork to qualify. The major deciding factor for many lenders, for example, is your personal credit score.
Personal loans often have lower lending limits than business loans, though, so you may not receive enough money to grow your business the way you want to. The lending amount for a personal loan tends to be between $1,000 and $50,000, while small business loans generally range from $13,000 to one million dollars.
Not only that, but annual percentage rates tend to be higher with personal loans, which can dig into your profits. To give you an idea, the APRs for personal loans in 2018 are between 10 and 28 percent, while average APRs for business loans are four to 13 percent.
These ranges might not seem too different, but interest can really add up — if you have a $25,000 loan being paid over three years with a five percent interest rate, you’ll pay just under $2,000. On the other hand, if you end up with an interest rate of 10 percent, you could pay more than $4,000 in interest. This is why it’s important to shop around and try to find the lowest APR possible.
It’s also important to keep in mind that as a sole proprietor, your personal credit score could take a major hit if your business fails. Plus, you’ll be solely responsible for repaying whatever you owe.
Business loans
Business loans, on the other hand, tend to have higher lending limits than personal loans, and usually offer both long- and short-term financing options, which can give you and your business more flexibility.
Business loans are generally more difficult to obtain than personal loans, though, especially for sole proprietors. Major financial institutions like banks, for example, are often hesitant to approve business loans for sole proprietors, preferring instead to lend to incorporated businesses. There are also legal risks that may give lenders pause. If someone sues you as a sole proprietor, for example, you may be more likely than an incorporated business to go bankrupt and be unable to repay your loan, since there’s no major distinction between your personal and business assets.
To qualify for a business loan as a sole proprietor, you typically need to have a solid personal credit score, and you may need to submit a range of financial documents during the application process, which could include tax returns, bank statements, a business plan, profit and loss statement, or cash flow statement. You may also be personally liable, which means you’ll be responsible for repaying any debts or losses your business incurs. And as with a personal loan, if your business fails, your personal credit score will likely be affected, too.
Comparing your options
When deciding whether to apply for a personal loan or business loan, it’s important to consider several key factors. First, check your personal credit score and determine how much money you need to borrow to grow your business, as well as what you plan to use the funds for. Are you looking to purchase new equipment? Rent a workspace outside the home? Hire a short-term work crew to help you complete a project?
You should also think about your long-term business goals. Maybe you want to increase your profits by 20 percent in five years, add a new service or product, or expand to another state. How will the money you’re borrowing help you achieve these goals?
Finally, figure out how soon you need the money, as well as the amount of time you can dedicate to the loan application process.
If you only need a small amount of money and want to take a slightly easier and faster route, a personal loan may be your best bet. Applying is simple and doesn’t usually require you to have financial records ready for review. Plus, depending on the lender, you can usually get approved in just a few business days. But be careful — they can come with higher interest rates, so make sure you check the APR so you know the true cost of your loan.
If you have big plans (and need a big budget) or want to try for a lower rate, however, a business loan is the way to go. While not everyone will qualify for the lowest rates, it can be a good option if you can afford to devote more time to the application process. Depending on the lender, it could take anywhere from hours to months to be approved for a loan, although some online business loan providers can cut that timeline down significantly. At minimum, qualifying for a business loan usually means you’ll be able to get more financing, which can give you the freedom to take on bigger projects that’ll help grow your business.
Whichever route you choose, do your research first, and make sure you have a game plan and a safety net in case you encounter unexpected issues. It may seem daunting to obtain the funding you need to successfully grow your business, but it’s also an exciting process, and one that has the potential to take your business to the next level.
