Pros and cons of startup business loans

Statistics from the Small Business Administration’s Office of Advocacy show that 67.7 percent of new businesses lasted at least two years between 1994 to 2020.

While only about half of startups last five years, this does not deter entrepreneurs. According to the U.S. Chamber of Commerce, 5.5 million new business applications were filed in 2023 — a record-breaking number.

If you want your business to be one of the success stories, it’s important to start your business strong. That can include ensuring you have enough capital and a steady source of cash flow to pay for costs like equipment, payroll, supplies and real estate.

That’s where applying for a startup business loan helps. But there are also potential drawbacks, like high fees or the fact that startup business loans may be difficult to qualify for. To see if a startup loan is right for you, check out the following pros and cons.

Compare pros and cons of startup business loans

Pros

• Access to capital
• Can retain ownership
• Can help build credit

Cons

• Strict eligibility requirements
• Can be costly
• May require a personal guarantee or lien

Pros of startup business loans

There are several main reasons you may want to look into startup business loans.

Access to capital

Startup business loans provide access to funds you can often use in many ways, including getting your business off the ground.

For example, lump-sum options like business term loans or equipment financing are often used for high upfront costs, such as product development, office equipment or semi-truck financing. A revolving source of capital, such as a business line of credit, can provide a revolving source of funds to use as you need, which can help cover day-to-day costs.

Retaining ownership

Startup business loans can save you the trouble of finding investors and selling equity, which means giving up partial control of your business. Depending on how much equity you sell, you may need to answer to the demands of investors. With a business loan, you keep full ownership and can run your business as you see fit.

Helps build credit

If you select a lender that reports your payments to credit bureaus, getting a loan can actually help your finances — as long as you make on-time payments and keep your debt low.

Building credit is an important step if you don’t have any or have bad credit, which makes it hard to qualify for loans with affordable rates. Even if you don’t need financing now, a loan or business line of credit could be a good way to build credit and ensure you are eligible for the best loan for your business down the road. Some lenders, like Bank of America, even have programs that help you build secured credit, and you can graduate to an unsecured line of credit down the road.

Keep in mind that not all business lenders report to credit bureaus. It’s important to check and make sure before you apply for a loan.

Cons of startup business loans

There are also several cons to consider before looking into business loans for startups.

Strict eligibility requirements

Startups may have a difficult time securing small business loans. A typical business loan requirement is a credit score of 600 or higher. Many lenders also prefer to see an established business that’s been around for at least two years and has annual revenues ranging from $100,000 to $250,000 or more.

These requirements can be difficult for startups to attain. According to the Federal Reserve Banks’ 2024 Firms in Focus: Chartbook on Firms by Revenue Size, 49 percent of businesses under two years old have annual revenue of $100,000 or less.

It’s possible to find more lenient lenders. For example, some are willing to offer secured business loans to startups and may not have strict requirements for annual revenue or credit scores. But your options may be limited and could come at a cost.

Costs

Business loan fees and interest rates can also be an extra burden on startups. The best interest rates are reserved for established business owners with good-to-excellent personal or business credit. Some lenders are less willing to help finance startup businesses as they are often seen as a risky investment. And those that do provide business loans charge higher rates to help offset that risk.

You may also have to watch out for fees, which vary by lender and type of startup loan. For instance, origination fees can either be a flat fee or can be a percentage — typically anywhere from 0.5 percent to eight percent. You may also have to deal with late payment fees, underwriting fees or even maintenance fees.

Personal guarantee or lien requirements

To get a business loan, you typically have to sign a document called a personal guarantee. This legal document states you are personally responsible for the company’s debt if you default on the loan. The lender may take you to court to recoup losses if you can’t repay the loan.

If you take out a secured business loan, you will have to provide some form of collateral, which is an asset that you put up to secure the loan and reduce the lender’s risk. The lender will place a lien on the asset, which is a legal claim giving the lender the right to seize the asset if you default on the loan. For instance, if you took out an equipment loan for a semi truck, used the truck as collateral, and defaulted on the loan, the lender could then take the truck.

Defaulting on a loan and losing your personal or business assets is a risk many business owners take. To be sure it’s right for you, you’ll have to make sure you can manage your small business loan well to avoid going into default.

Where to get startup business loans

Traditional banks may be an option, but they typically have the most stringent requirements. Here’s a look at lenders who tend to be more accessible.

SBA loans

SBA loans can have a reputation for requiring a lot of documentation. The approval process can also take anywhere from 30 to 90 days. But they can be an affordable and accessible option for startups. There’s even a microloan program that provides $50,000 or less, which can be used to help businesses get up and running.

Online lenders

Since startups and small businesses can have difficulty securing traditional bank loans, various online lenders have stepped up. Many specialize in working with startups, and small businesses offer loans with relaxed eligibility requirements and faster approval and funding times.

Alternatives to startup business loans

If you decide a small business loan isn’t right for you, here are some common alternatives to consider.

Bootstrapping

Bootstrapping is the process of only using your personal funds or operating revenue to finance a business. This can work well in cases where the business’s overhead is low, such as running a consulting business out of your home. People who bootstrap a business often dip into their own savings, take on personal debt or cut as much costs as possible when starting a business.

Business grants

Business grants are typically offered by government agencies, private corporations and nonprofit organizations. Since they don’t have to be repaid, they can be hard to come by, as competition is fierce. But they’re still worth considering, especially for the chance to get your business up and running without the burden of debt.

Business credit cards

Business credit cards can help cover short-term needs for business owners. They’re similar to business lines of credit but may offer unique perks like rewards, discounts on select purchases, intro APR offers and more. You can also use business credit cards to build business credit and even possibly avoid interest charges if you’re able to pay your balance off each month.

Crowdfunding

Crowdfunding is a popular option involving an online platform to run a fundraising campaign. It takes more time and energy than taking out a loan since you’re raising small amounts of cash from multiple sources. But this is a viable alternative for startups struggling to get loan approval.

Bottom line

The best startup business loans are an option for getting upfront cash to get your business up and running. They may also help build credit, which can lead to more affordable loans down the road.

But make sure to consider all your options before applying, as there are risks to consider, including high rates and fees. If getting a startup loan isn’t right for you, consider alternatives to fund your startup, such as crowdfunding or business credit cards.

Frequently asked questions

• Is it a good idea to get a loan to start a business?

  While getting a business loan for a startup is risky, many startups need a loan to get off the ground. You may choose to take out a business loan if you have a solid business plan and a product or service that’s highly marketable to your target customers. But if you’re new to the market or don’t have data to back up whether your business will succeed, you may want to start the business first and get a business loan later to help you grow.

• Who offers loans to startup businesses?

  Small business startup loans are offered by banks, credit unions and online lenders. While online lenders tend to be more accessible to startups, it’s worth looking at traditional options like banks and credit unions to see if they’re willing to work with you, as they tend to offer more favorable rates and terms.

• Is it difficult to get a startup business loan?

  It can be difficult to secure a business startup loan if you are going through a traditional bank, which tends to work more with established businesses that have been around for two years or longer. Online lenders are often less stringent, and some specialize in working with startups but may charge high rates and fees.