Starting a business costs money, so it’s important to consider how you’ll find funding to get it off the ground. After building a business plan, many entrepreneurs approach banks to apply for loans to buy equipment or open a physical location. That said, these are the reasons in which you might benefit far more from self-funding than taking out a loan.

This article will highlight the disadvantages of taking out loans:

  • Interest
  • Liability
  • Stress and pressure on relationships
  • Effect on credit score
  • Eligibility

We will also offer some information on the alternative:

  • Self-funding

Interest

The first and most obvious downside to taking out a loan is that you have to pay it back. Not only that, but you have to pay for the process of borrowing. A fee that will rise the longer it takes you to pay back. 

The cost of borrowing is sometimes not divided equally amongst the population, and businesses are no different. A wealthy individual might borrow to purchase assets they can sell while a less wealthy individual might borrow to keep themselves afloat. It is similar for business: a larger business may benefit highly from lending money because you don’t pay taxes on borrowed money since it is not classed as income. 

On the other hand, smaller businesses are unlikely to be able to pay off the loans quickly or make quick returns, meaning they won’t benefit as much from avoiding taxes either. According to a report by Statista/Forbes, the second top reason most businesses fail is that they run out of money. If you ever take out a loan and you run out of it, that opens you up to far more problems than you started off with.

Liability

If you are a sole trader who has just started a business, you have unlimited liability. This means you and the business are legally the same entity. So if your business owes money, you are personally liable to pay it, and that includes loans. 

If you cannot afford to pay back your loans, then your bank or lender has the right to seize your personal assets instead. Depending on the size of your loan, this could mean losing cars, furniture and even your home. 

According to the Statista/Forbes report, the top reason that startups fail is that there is simply no need for it in the market. Losing your investment because you found out your product or service does not sell is one thing, but it would be far more distressing to lose your personal belongings as well.

Stress and pressure on relationships

A study carried out by the Royal College of Psychiatrists found that of all the adults who have a problem with debt, half have mental health problems. The problems ranged from anxiety and low mood to diagnosed conditions. The study also found that having debt issues negatively impacts sleep in these adults, which often affects work and, in turn, increases their debt.

It is also common that the stress of being in debt can start to put pressure on your relationships. This is especially the case for couples, where debt issues often lead to arguments and an erosion of trust. It is an additional risk that taking out loans can have that many overlook.

Effect on credit score

Missing loan repayments can start to have an effect on your credit score, which may impact your life in the future.

A poor credit score may prevent you from:

  • Securing mortgages for a home
  • Setting up phone contracts
  • Getting car insurance
  • Securing certain jobs
  • Renting a flat

With your credit score able to determine your ability for so many things, it may be worth considering when thinking about taking out that business loan.

Eligibility

Aside from the prospects of taking out a loan and the negative effects of doing so, there is the possibility that you are unable to — small business loans can be difficult to get, especially if this is your first venture. 

Some factors that affect your ability to get a small business loan are:

  • Poor credit history – if going into the business, you already have a low credit score
  • Limited cash flow – banks will look at your forecasts closely to see how likely you are to be able to pay them
  • Poor business plan – if your business plan is not convincing enough, you may struggle
  • Taking out too many loans – if you take out multiple loans, they can find out and reject your application)
  • Lack of expert advice – banks will judge your viability based on whether you have any advice from an accountant

Why self-funding a business is better than taking out a loan

According to a report by Statista, the global e-commerce market was worth $4.28 trillion (£3.2 trillion) in 2020. By 2022 it is forecast to reach $5.4 trillion (£4.1 trillion). Therefore it’s clear that the future of business is online, and many do not need a physical store. With this, the need for funding is likely reserved for equipment, supplies or marketing. 

Although, it’s worth noting that huge companies with colossal advertising budgets can still fall short with the wrong campaign. That’s why it’s important to be smarter with your marketing rather than throw money at it. You can find more advice about smart marketing at the bottom of this guide.

To pay for smart marketing, supplies, equipment or rent if it’s needed, here are some reasons why funding it yourself through personal savings is beneficial:

  • You know exactly how much is going into the business from the beginning – putting yourself in a position to best organise from the beginning, rather than relying on other sources of finance
  • You don’t need to worry about paying it back – if you are the owner of the business, you can choose your own salary and pay yourself back when you see fit
  • By self-financing, you do not dilute your share of the business – meaning that you get to maintain control of the venture and get to benefit from the profits solely
  • Knowing it is your money means you will take care of it – you may be more mindful of your spending knowing that you earned it 

Make tracking your funds a breeze

Financial management can be stressful and time-consuming when you’re self-employed. That’s why thousands of business owners use the Countingup app to make their financial admin easier. 

Countingup is the business current account with built-in accounting software that allows you to manage all your financial data in one place. With features like automatic expense categorisation, invoicing on the go, receipt capture tools, tax estimates, and cash flow insights, you can confidently keep on top of your business finances wherever you are. 

You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward! 

Find out more here and start your 3 month free trial today.

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