What You Should Know About Incurring Startup Debt for Your Business

As a small business owner and a business law attorney, I understand that starting a new business venture requires money—or capital, as it is often called in the in the corporate world. Some new owners fund their fledgling business through investors or with money they have set aside for just that purpose while others take out loans. According to a new study, the type of loans that a business owner takes out may be linked to the future success of his or her company.

Business vs. Personal Loans

Unless a would-be business owner has substantial savings or a financial backer, he or she will probably need to take out loans to cover the costs of getting started. There are two primary types of borrowing: business and personal loans. A business loan is made to the business as an entity, and the debt remains in the name of the company. A personal loan, by comparison, is made to the individual, which he or she can then use to fund the business. The borrower remains fully responsible for a personal loan, regardless of the how the money is spent.

Predictors of Success

Two finance professors recently released the results of an analysis they conducted regarding the health of startup businesses and the types of debt incurred. Rebel Cole, a professor at Florida Atlantic University, and Tatyana Sokolyk of Brock University in Ontario, Canada, looked at data collected in series of surveys collected by the Ewing Marion Kauffman Foundation—a non-profit dedicated to helping young people realize their potential in the business world. The surveys included information about some 5,000 business that began operations in 2004.

The researchers found that companies funded by business loans, on average, generated twice as much revenue after three years than businesses that took on no debt. On the other end of the spectrum, companies funded by personal loans generated nearly 60 percent less revenue than debt-free businesses. This means that a company with business loans generated an average of four times more than a company with personal debt.

Possible Explanations

The professors offered a few potential reasons behind their findings. First, they said that businesses that are most likely to succeed are also the most likely to ask for business loans. A business loan requires preparation, a well-thought-out business plan, and the investment of time and resources. An owner who is willing to go such lengths is serious about the company’s future. Banks are also more likely to offer loans to businesses that appear viable and then monitor their investments and provide guidance to owners.

When a bank encounters a start-up that it is unsure about, the institution is more likely to push the applicant toward personal loans, the researchers said. Personal debt also limits what funds may be available to the owner in the future. Therefore, business owners must be more careful with spending, and if unexpected problems arise, owners may struggle to find the financing to deal with them.

Call a DuPage County Business Start-Up Lawyer for Help

If you are looking for information about financing your idea for a small business, contact an experienced Naperville business law attorney. We will help you explore your options and make the best possible decisions for your new venture. Call 630-228-9413 for a confidential consultation at the Gierach Law Firm today.

Sources:

Forbes

Ewing Marion Kauffman Foundation

ScienceDirect