This article is for educational purposes and does not constitute legal or tax advice. For specific advice applicable to your business, please contact a professional.
According to a recent Federal Reserve Small Business Credit Survey on Employer Firms, business owners applied for financial assistance based on a range of needs. The leading reason was to meet operating expenses. Expanding their business, pursuing new opportunities, and acquiring business assets ranked as the second reason for applying for financing, and the third was in order to refinance debt.
Taking on outside financing, whether it be through crowdfunding, investors, or a loan could be a crucial step in growing your business. When it comes to loans, they can come in many forms and serve a variety of purposes. If you’re considering a business loan, it may come in a secured or unsecured form.
The difference between business loans and personal loans
The main difference between a personal loan and a business loan is that personal loans are intended for personal purchases and business loans are intended for purchases related to the business. These business expenses could include equipment, inventory, business debt consolidation, and more.
Secured vs. unsecured business loans
Business loans can come in both secured and unsecured loan form. The differentiator between a loan that is secured versus unsecured is whether or not that loan is backed by collateral. Unsecured loans don’t require any form of collateral where secured loans do. Collateral in this case can be a house or car, for example. If the loan isn’t paid back, the lender could then seize that collateral as payment.
An unsecured business loan not backed by collateral may require a personal guarantee. Alternatively, this loan could be extended based on the business’s revenue. In both cases, the business owner’s ability to qualify for the loan is determined based on a number of factors that may include credit or business revenue. Typically unsecured loans carry a higher interest rate than a secured loan.
Examples of Secured loans
Below are examples of common types of secured loans:
- Auto loans
- Mortgage loans
- Home equity lines of credit (HELOC)
- Life insurance loans
- Secured business or personal loans
- Secured credit cards
- Secured lines of credit
Examples of unsecured loans
Below are examples of common types of unsecured loans:
- Unsecured personal loans
- Credit cards
- Student loans
Best practices before taking out a loan
There are many factors taken into account to determine whether your application for a business loan will be approved or rejected. These factors change from lender to lender.
- Maintain your credit: According to a 2018 National Small Business Association survey, 20% of small business loans are denied due to credit issues. If you are applying for a business loan and your credit score is being taken into account, there is a difference between a personal credit score and a business credit score. Personal and business credit scores have different ranges and maintaining separation between the two could help minimize risk.
- Length of business history: Consider how long your business has been in operation. Businesses with a very short history could potentially be riskier to a lender as there isn’t much history to gauge whether or not you can repay the loan.
- Keep track of business documents: Documents that help prove the financial health and viability of your business may be requested by a lender. These documents vary but could include a business plan and loan proposal, financial statements, and loan application history. The Small Business Administration (SBA) requests the following documents.
- Know your debt-to-income ratio: A debt-to-income ratio may be considered in the application process for a loan. This ratio is a way to assess if the business’s debt and equity could pose a financial risk to your business.
If you are a Square seller, Square Loans automatically extends an offer through the Loans tab of your Square Dashboard. Payment frequency, business health, and customer mix are among the factors that are used to determine eligibility.
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