The word “debt” conjures up images of home mortgages, crippling student loans, and credit card balances carried forward month to month.. Those are generally for expenditure on consumption by individuals. Debt in terms of small startups generally involves funds borrowed by company founders to make investments. The hope is that those investments will yield returns that will then help repay entrepreneur debt with interest in the short run and continue to yield returns long after the debt is repaid.
Usually, founders approach banks and other lending institutions only after running out of options, such as attracting more seed investment. The reason for this is that taking on personal debt for running a startup is highly risky. Startups are notorious for failing or becoming profitable after many years. This may not give founders enough of a time cushion to find funds in order to repay debts. Not having that is bound to play on their minds and add to the already huge amount of stress.
How to Handle Debt as an Entrepreneur
Borrow as little as possible with a repayment period as long as possible
Before taking the plunge on personal debt, founders should work with their accountants first to figure out how much is required and how soon. Minimizing the amount borrowed over a longer period of time gives founders room for spacing out debt repayments.
Friends and family
Depending on your familial relationships, this is a route that can be considered. Sometimes, multiple family members may be willing to lend small amounts each. This way the burden is not too much for one single person. The greatest risk in taking family loans is that inability to repay loans may affect personal relationships. Also, if you fail to return these loans, this avenue may be closed to you after that.
Look into crowdfunding
If attracting investments from angel investors or VC firms is not an option, you can look into the possibility of crowdfunding. This is especially possible if the proposed product or service sold by your startup has a mass appeal or appeals to certain niche markets. In either case, it is important that the layperson be able to understand the goal of the startup without over-explanation.
Check out the lending institution
If a lender is willing to give you a loan without requiring you to have a decent credit score, be extra careful. It is likely a scam. It may be worth your while to take steps to build up your credit score and take a loan from a legit source.
The U.S. Small Business Administration’s microloan program offers loans of up to $50,000 for small businesses, the average microloan being about $13,000. These are easier to secure than larger loans, but may be insufficient for your needs. These are administered by nonprofit community lenders and are typically easier to qualify for than larger-dollar loans. Some focus on business owners who belong to minority communities. These are great starter loans. The amounts available may not be sufficient for all borrowers. However, these microloans may help you secure larger loans in the future.
Business credit cards are another option. This should only be used for immediate needs that can be paid off quickly. Approach this option with care. Generally, small businesses that rely heavily on credit card financing typically fail.
Private foundations and government agencies offer grants for small businesses. There may be specialized grants for veterans as well as women. This is essentially free money. However, be prepared to spend time on preparing lengthy and tedious grant applications. Also, there will be deliverables.
Do the math
Look into the nitty-gritty of loan agreements. According to the Federal Reserve, the current average APR for a two-year personal loan is 9.58% while the average APR for a credit card is 16.30%. The repayment period may range from a few months to a few years. Some lenders may charge a fee if you repay the loan earlier than the set period.
Other than the points mentioned above, make sure you have a sound business plan. Have advisors who are not shy to list out your blind spots. Address all of them before you take loans. Successful repayment leads to a rise in your credit score and increases your chances of lending money in the future. The converse could spell disaster for your business as well as your personal financial reputation.
Have any more tips for handling debt as an entrepreneur? Let us know down in the comments.
This article originally published on GREY Journal.