.webp)
Whether you’re scaling a startup or expanding a mature company, meeting your business objectives will require some capital. Entrepreneurs often apply for business loans to cover the costs of key business functions, whether it’s a small business administration (SBA) loan, credit line, or equipment financing plan.
However, business loans, as beneficial as they can be in certain circumstances, have their drawbacks. Understanding the pros and cons of business loans is essential before considering them as a financing option. Knowing the advantages and disadvantages of loans can help you make an informed decision, whether pushing through with bank business loans or other financial alternatives.
Founders of industry giants ranging from Apple to eBay have been championed for bootstrapping their companies from the ground up. However, some business owners lack the resources to scale their companies, which is where loans may come in handy. In situations where funds are limited or difficult to generate, loans can serve as an accessible means of financing. Here are some key business loan benefits.
The most basic benefit of a business loan is access to immediate funds. With up to 80% of businesses failing due to insufficient capital, it's clear why loans are a staple source of financing—they keep cash flowing to cover business expenses. A business loan can cover the costs of inventory, hiring new talent, product development, and just about any other business function you can imagine.
With some options, such as equity financing, capital is raised through the sale of shares and, investors will expect some profits and control in return. Business bank loans help entrepreneurs by providing the necessary funding while avoiding the need to give up control of their business."
Another business loan benefit is flexibility. Banks and online lenders tend to be flexible about deadlines and payment structures and can adjust them to your needs. You can also apply for various business loans—working capital loans, startup loans, and auto loans—that offer larger amounts than online lenders typically do.
Additionally, interest rates, although highly variable, can skew in your favor depending on your creditworthiness, collateral assets, and loan size. For those with prime credit profiles, interest rates can be as low as 3%.
Certain aspects of business loans are tax deductible. Although business loans are not considered tax-deductible income, you can subtract the interest incurred on money borrowed for your business. With that said, the amount of deductible interest varies and must fall within CRA limits.
When weighing the pros and cons of business loans, entrepreneurs, especially small business owners, often skip over their disadvantages. After all, when you gain access to new funding, the benefits of financing seemingly outweigh the drawbacks. Nevertheless, drawbacks can creep up, resulting in greater costs than what you would have faced without a bank business loan.
One of the biggest disadvantages of loans is that they are a form of debt. Yes, they can be a financial lifeline when funds are otherwise unavailable, but they can reduce cash flow and limit borrowing capacity. If your business has high operating costs and limited earning potential, a loan payment can put you in a vicious cycle where you struggle to stay on top of your payments.
Business loans are no different from personal loans, where you can accrue negative equity. Interest costs and additional fees can exceed the loan principal. You might call it a “necessary evil,” but in the context of business, added fees increase your debt burden.
Read more: How To Achieve A Debt-Free Financial Status?
Defaulting on a business loan can have severe consequences that affect you both professionally and personally, including losing collateral you acquired to scale your business operations. For example, if you purchased a delivery truck or a commercial warehouse, the lender could seize it to recover the money they lost from the default.
A lender can also come after your personal property to recoup their money, including your home. But even more alarming is that lenders can garnish wages and even pursue legal action in some cases.
If you were to default on a business loan, two things happen to your credit. First, your business credit score takes a hit, since lenders will report late monthly payments, judgements, and collections. Secondly, poor business credit affects your personal credit score as well. This compounds the problem, with two damaged credit scores making future borrowing even more difficult.
Keeping the pros and cons in mind, the question remains whether you should secure business loans or not. Business loans have their merits and can be a beneficial choice, but the drawbacks often outweigh the benefits.
For example, in 2023 alone, 60% of business owners struggled to clear existing business debt due to rising interest rates. Small businesses, in particular, often depend on loans with fluctuating terms, which can lead to financial instability and added challenges.
Read more: How to Protect Your Business from Rising Interest Rates
The limitations of business loans has led to alternative lender options, each one addressing the pros and cons of loans in various ways.
These loans are issued to businesses without access to traditional financing. They connect borrowers and lenders without the middleman (banks). The loan amount is usually minor compared to traditional bank loan amounts and has short repayment deadlines with no collateral required.
Originally used primarily for mortgage loans, P2P loans are secured from individual lenders, not a bank. They have become more readily available to business owners looking to finance their companies without the risks of traditional business term loans. While P2P loans can have higher collection fees, they often come with lower costs and better interest rates.
Also known as “accounts receivable financing," invoice financing works by selling your accounts receivable to a funding provider in exchange for cash to pay for business expenses. It’s an alternative to borrowing that minimizes poor credit risks since you don’t have to put up collateral.
At REV Capital, we offer invoice financing as an alternative to traditional loans and recommend it as a go-to option for its low-risk, easy-funding nature.
Understanding your loan options is crucial before applying for one. More importantly, knowing whether to choose a business loan or an alternative can determine whether you experience financial growth or face overwhelming debt. REV Capital is committed to helping you achieve the former.
Invoice financing helps you cover your business expenses quickly, without the added risks of defaulting that come with traditional loans. Our approach is personalized to your needs, ensuring you understand how the process fits your business.
Contact us today to learn how our invoice factoring solutions can help you finance your business growth for long-term success.
%201.svg)
