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Ask Geri: Should I Take Out a Loan to Finance a New Business Venture?(5-min read)

Hi Geri,

Should I take out a bank loan to finance a possible business venture?
– CS (asked in person)
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Hi Seatmate CS,

My long three cents: Yes and No.

Taking out a loan provides financial leverage in a sense that we get an amount in lump sum upfront, and we get to pay it in staggered smaller amounts, in exchange for interest (i.e. cost of borrowing). Know as well that failure to make timely payments and defaulting on a loan will affect your credit worthiness in taking out future loans and other credit facilities.

Psychological and Emotional Impact

The tendency of people (including me) is to be hesitant to use their own money when it comes financing a business, especially if the amount will eat up a sizable portion of Juan’s savings. Maybe because it will be a one big painful blow, it will hamper cash flows, it will eat into emergency funds (which should not be the case) etc. Or maybe because if Juan will get a loan instead, the impact to finances and emotional pain is bearable (paying in smaller amounts) compared to shelling out of pocket a big amount. We prefer it small and slow.

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Net Worth Impact

Accounting-wise though and in terms of Juan’s net worth, taking out a loan is more detrimental as it adds more liabilities (i.e. principal and interest expenses) than assets (drawn cash from loan possibly less fees). Whereas using Juan’s own money to fund a business is just a transfer of assets (cash to business capital), at no interest expense. Save for opportunity costs, if any.

But decisions must be made beyond the accounting implications.

YES. 

Personally, I would strongly consider taking out a loan to fund a business venture as long as my monthly cash flow (from other sources) can pay for the monthly amortization. And yes I’m willing to pay the interest expenses rather than suffer a big blow in my current savings. Yes, even if the business does not yield any cash flow soon, or worse none at all (i.e. failed venture in hindsight). I will still give it a try as long as I believe in its potential.

That is why it is important that Juan can repay the loan whether or not he derives any profits from the venture. If Juan finds the business promising and has potential to be successful, then that is added reason for Juan to consider a loan. Hopefully the business does bear fruit to a point that it can already repay the monthly amortization and then some amount is still left for re-investment. There’s also the chance that not the whole amount has been expended yet, as such Juan can readily stop the funding of the business if early indications are not so encouraging. Then just pre-terminate the loan.

There’s also business loans where a portion of the business or its returns may be owned by the lender. Securing one is a bit more tricky though than a plain and simple personal loan. But still, regardless of what loan it is, I’d rather not rely on business cash flow alone to repay the loan.
Juan can also approach it this way: in funding major expenses such as a home improvement or getting car, tendency is to take out a loan rather than deplete Juan’s savings. No monetary return (i.e. actual cash inflow) is expected from a much improved home or new car (except for appreciation in property value and net worth) but Juan is still willing to get a loan as long as he can pay for the amortizations. What more a business wherein there is a chance, no matter how small, of a monetary return.
 
Loan Officer by MarkMoz12, on Flickr

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NO.

Of course the inverse of my yes. No if I loan repayments will depend on the immediate success of the business, since worst case scenario, Juan might default on the loan and end up in deeper sh*t than where he started. Related to 3Ps of business start ups, many business ideas seem promising but Juan lacks the funding to make it a reality. Or most of the time, Juan lacks the guts to make the jump. Still, I wouldn’t dare if the required loan is too big that my present cash flow cannot afford it. Don’t want to end up with a failed business and a delinquent loan.

That’s just me though and my risk appetite. I’ve read about start ups that were funded by loans, virtually from nothing but the loan, ventures that were really relying on every bit of business cash inflow to repay the loan, and were eventually successful. We have these sorts of success stories. But I think these are exceptional, one in tens or hundreds.

This should not stop us from trying though. The point is to be careful on whether to take out a loan or not vis-a-vis Juan’s capacity. Determined but not stubborn. Cautious but not idle.

Middle Ground

Lastly, consider other loan sources. Like credit cards if the amount is small anyway, can be transacted with a card (like equipment purchases) so that Juan can take advantage of the interest free billing cycles. Just make sure to pay in full the amount due since if you revolve, you pay much higher interest than a normal personal loan
Or try borrowing from friends and haggle for lower rates (it any at all) and flexible payment terms. Again just make sure you can pay whether the business works or not. Otherwise it might be friendship over plus business over.
As for the business, if it works, good for you. If it doesn’t, charge it to experience. Pun intended.
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