Private Loans – The Pros and Cons

If you’re like most business owners, there comes a time when you are ready to grow your business, but don’t have quite enough capital to take that next step. Could you use funds from private loans?  This could be a turning point for a small business, find that money and grow, or don’t find that money and stagnate.  Getting a loan to grow your small business in this economic climate is not an easy task.  But a smart business owner knows there may be multiple options available.  Which avenue should you choose?  Maybe you can qualify for and get a bank loan; maybe private loans are the quick fix you need, especially if you have a friend, family member or guardian angel to help you take that next step?

Maybe you don’t have the luxury to time to fill out a load of paperwork at a bank and wait for what seems like (and could be!) forever for an approval.  Maybe previous credit problems are severely restricting your access to traditional means of credit. So, whether you wish to avoid traditional loans or do not have access to them, you will need another source of funding if your small business requires outside financing.

What are Private Loans?

Simply put, private loans are loans from non-bank entities.  This type of loan originates from entities that believe that your business has growth potential and will lend you the money to go for it!  Yes, loans from mom, dad, and great grandma Ruth qualify in this category.  As do loans from “angel investors”, venture capitalists, or financial institutions that have specific loan programs for people just like you.

How to Get a Private Loan

If you’re wondering how to get a private loan, look no further than our analysis of private loan options below. We’ll share a few sources as well as the pros and cons of each below.

Private Loans from Family and Friends

You probably have heard the saying that blood is thicker than water, but when it comes to business loans from family – you have to know if blood is thicker than money.  From friend to friend, parent to child, child to parent or brother to sister, borrowing money from someone makes you beholden to that person.  Whether written or unwritten, when you borrow money, it changes the power dynamic, so be prepared.  You don’t want to enter a situation where your mom now thinks she is “your boss” because she agreed to give you a loan.

Even with all the “potential” pitfalls of borrowing money from friends and family, securing a private loan from someone close to you does have its benefits.  Borrowing money from a family member or friend really can be a simple and timely way to obtain financing for your small business.  People close to you will know you and your business well, and will want to help you succeed.

So if you are still thinking about asking mom and dad for that loan to boost your business, take a moment to think through the pros and cons of this type of loan.

Pros of Loans from Friends and Family

  • Easy accessA private loan will not require you to fill out a mountain of paperwork and sign your name 1000 times.
  • No collateralIn most cases, you will not be required to put up your home, business, and first born child as collateral.  Unless Grandma Ruth would like someone named after her.  You may need to do that if the loan is not repaid in time.
  • Interest rate not tied to Libor or other index A family or friend is likely to be more lenient than a financial institution in terms of an interest rate. On average the interest rate on private loans is very close if not lower than the going interest rate, which is less than you’ll get through many other sources.
  • No background or credit check requiredSince you will be borrowing money from someone you know well, you have probably already made them privy to your financial details.  You will still get your private loan from Grandma, even though she knows you bounced a check or two.  A friend or family member probably won’t run a credit check on you. This is a key benefit if you have credit problems.
  • Flexible termsWhile just about everything is negotiable, you will have much more flexibility around the length, payment date and loan amount then you would if you were dealing with the finance manager at the local bank.  You and your friend or family member can work out terms that are convenient for both of you, so that it becomes a win-win situation.  And, since you are close to these people, they will likely be amenable to changing terms if needed.

Cons of Loans from Friends and Family

  • End of a relationship?-You have to consider that you may ask someone for a loan, and their answer will be no.  Would it change your relationship with this person, or how you feel about them?  Also, consider what could happen if you do end up taking that private loan.  What will happen if you miss a payment, or can’t pay it off at all?  It may totally alter your relationship with your “lender” forever.
  • Lack of formality and rigorYes, not filling out a mountain of paperwork is definitely a benefit!  But, it can work against you if either person feels the other is not living up to their side of the “agreement.”  The lack of a written agreement could turn litigious if either side becomes dissatisfied with the loan. If you don’t have terms on paper you will end up in a he said/she said situation where no one comes out the winner.

If you determine that using a friend or family member as a private investor is not right for you.  What other options do you have?  Maybe you can find an “angel investor?’

Private Loans from Angel Investors

Not familiar with the term?  You should be if you are thinking about a private loan!  An angel investor (also referred to as an angel or business angel or informal investor) is someone with a substantial bankroll that is willing to provide capital for a business, usually in exchange for convertible debt or ownership equity. Angel investors are definitely a viable option for a private loan if you are a small growing company with solid a business model and prospects for rapid growth.

Pros of a Loan from an Angel Investor

  • Can provide capital in small amounts – Small businesses usually need a small “shot in the arm” to spur growth, usually less than $500,000.  Angel investors are able to provide private loans for this amount using their own personal funds unlike venture capitalists that typically pool money from different sources, generally invest in later-stage and invest in enterprises that need far more than $500,000.
  • Flexibility – While angel investors may not be as flexible as mom and dad, they do offer some flexibility.  When it comes to loans, angel investors have much looser requirements than traditional financial lenders, including banks and venture capitalists. Because they are investing their own money, sometimes heart and soul will win over a credit score.
  • Knowledge and experienceWhile mom and dad may provide you a private loan and maybe a shoulder to cry on, angel investors can bring their invaluable experience to the table.  Many angel investors have walked many a mile in your shoes themselves and have founded and led several successful companies in the past.  So along with your business loan they may be able to offer you support, expertise and business contacts, all of which can help your business grow.  It’s difficult to put a price tag on an angel’s insight and resources.  For a small business owner receiving a financing from an angel investor, the experience they bring to the table is the icing on the cake!
  • Keeping it localMany angel investors choose to invest locally. The private loan that they finance for a growing business may also provide benefits for the community.  Helping a business grow can create opportunities and help stimulate economic growth by encouraging consumers to purchase their products. Angel investors like to invest back into the communities that helped them grow, paying it forward.  They can take pride in using their expertise in giving back to their community. Again, since they use their own funds for private loans, they sometimes look beyond a monetary return on investment.
  • Depth and breadth – These days, angel investors can be found everywhere, not just in traditional financial centers and districts. They also invest in nearly all markets worldwide. The majority of them are involved in industry-specific investments, according to their personal level of expertise.  Regardless of the market sector that an angel is involved in, what attracts an angel investor to a specific venture is the potential for a company’s profitability and growth.

Cons of a Loan from an Angel Investor

  • Loss of control – While an angel is giving you a private loan, it doesn’t mean you are handing over your business to them.  While the level of involvement will vary from investor to investor, it is not unheard of for an angel investor to have a certain amount of control in running a company.  You may unwillingly be forced to give up some degree of control to make your angel happy.Angels can become controlling and will want to protect their investment in many ways.  They might ask the business to agree to not take certain business steps without their authorization.  In other words, they are not simply buying a share of the company, they are in fact buying their power to control and influence how the business will be run.  It might make sense in the angels’ point of view, since they are investing a large amount of money in risky and not well established companies that has potential to grow.  Most angels won’t invest in your company if they are not the one who is running the show, or at least have you run the show the way they want it.
  • No national organization – It’s hard to find an angel if you need one.  Hope that one will find you!  While there are well-documented directories of venture capital firms available, there is no national register for angel investors. Compared to venture capital firms, angel investors are much harder to research and contact. Whereas venture capital firms are required to register with the U.S. Securities and Exchange Commission, angel investors are typically individuals who may not invest enough seed funding to trigger SEC regulations.

 

Not sure that an angel on your side is the private loan financing for your business?  There are still other types of private financing that may be right for your growing business. For instance, you could get approved for a business line of credit through Kabbage in under 7 minutes.  Balance what you need for your business with what you are comfortable with sacrificing and watch your business grow!

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