Advantages and Disadvantages of Small Business Loans from Banks

Startups usually require investment funds to cover their initial expenses. Consider the cost of undertaking tasks such as product development, hiring a team, marketing, and other crucial activities necessary to get the business off the ground.

Funds are also required to enable startups to scale up and reach their target market more quickly. The investment can come from various sources, such as venture capitalists, angel investors, or crowdfunding platforms.

The budding entrepreneur, on the threshold of starting a new venture, must determine where and how he or she will get access to sufficient funds.

Banks are almost always the first choice for a loan. However, banks also have strict criteria, and the harsh reality hits many enthusiastic entrepreneurs that the loan approval criteria are challenging.

A select few startups manage to fulfill all the prerequisites for a bank loan; however, for every successful loan application, many get rejected.

Banks are not the only source of business funding. As mentioned earlier, there are second-tier lenders, such as lawyers, insurance companies, angel investors, venture capitalists, and crowdfunding. However, as the first go-to is a bank, let’s consider the pros and cons of small business loans from banks.

Bank Loans for Small Business

Small business loans from banks are convenient but often come with harsh qualification conditions. Yet banks are more trustworthy than other lenders due to the compliance management process.

How does a lender become a bank?

To become a bank, a lender must obtain a charter by meeting specific regulatory requirements such as capitalization, governance, and risk management standards.

Plus, lenders keen to become banks must offer a range of financial services, maintain deposit insurance, and adhere to banking regulations and laws. The process of obtaining a charter can vary by country and jurisdiction.

A lender’s transformation into a bank can take several months to a few years, depending on the complexity of the application and the efficiency of the regulatory approval process.

Advantages

What are the advantages of using a bank for a business loan?

• Convenient and accessible – Banks are always accessible since they are used regularly for depositing or withdrawing savings. After being a bank customer for years, the bank has become convenient and familiar, and personalized service makes it the first place to consider a loan. Developing a good relationship with a bank can offer potential financing opportunities in the future.
• Multiple Loan Options – banks advertise various schemes to woo entrepreneurs setting up or running a business. A bank’s real earnings come from the interest they charge on these loans. Options like term loans, standard business loans, and others are available to the entrepreneur. Plus, there may be flexibility with the repayments.
• Nonprofit sharing – Did you know venture capitalists and angel investors agree to provide a loan in exchange for part ownership, the right to influence decision-making, and a share of the profits? Banks do not ask for any of these requirements. When they sanction a loan, they are only interested in getting their interest and partial loan payment installments.
• Lower interest rates – banks provide loans at lower rates than other lending agencies and instruments like credit cards.
• Scalable borrowing – may have access to more significant amounts of money than other lending options.
• Bank loans offer tax benefits — small businesses taking loans from banks enjoy some relief from tax since the percentage of profits used to repay the loan is exempt from tax.

Entrepreneurs approach banks for various loans due to their advantages. However, getting a business loan approved by a bank is challenging.

Disadvantages

The disadvantages of business bank loans include:

• Lengthy application process – banks need to verify all the credentials and details about the business before sanctioning a loan, so the application process is lengthy and requires a lot of documentation.
• Preference is given to existing, running businesses – banks prefer running businesses because they can gauge their profitability and credit history before sanctioning the loan. Startups and companies with poor credit face challenges securing loans due to strict credit and revenue requirements.
• long list of prerequisites to qualify — banks have a long list of conditions that a business must comply with before they receive the loan. It is often difficult to meet all of them.
• Risk of losing collateral – bank loans are generally sanctioned against some collateral, often the entrepreneur’s house and property. This stands the risk of being lost to the bank should the business fail to take off.
• Entire amount not granted – banks are known to not agree to grant the whole amount requested for a loan. They may grant 70 or 80 % of the sum applied for. This makes it difficult for the entrepreneur to begin since he or she has to scout for the remaining balance.

Thus, it is the balance between these advantages and disadvantages that prompts people to approach banks for small business loans. While raising funds is an essential part of business, so too is budgeting and having someone in the business with a keen eye on keeping costs under control and within budget. Anyone in business can reap the rewards of financial education and professional advice.

Before deciding on the best financing solution for your small business, it’s crucial to carefully evaluate the pros and cons of all available options.