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Once a week, we post a question on the site that's come from one of our readers. This week it's from an aspiring business owner debating whether to raise funds from the bank or from private individuals:
Question:
Hi Gareth,
I am currently planning to start a business. I have got everything planned how and what I want to do. The only thing is that I do not have the capital to carry me for atleast 3 months.
What do you think is the best way to get these finances? Take a small loan from a bank or to borrow money from a individual and repay them back?
Please if you could advise what the pros and cons are?
Thanks
Eduardo
Answer:
Hi Eduardo,
My opinion is that, when you can, you should always borrow from friends, family, or individuals in your network. While borrowing from a bank can help build up your credit record, I see the cons as follows:
1. It can be an administration nightmare to apply, and very frustrating.
2. If they do lend to you, and you don't have an outstanding credit record already, they will probably charge you pretty high rates of interest (to compensate for the perceived risk of lending to you).
3. They will often make you sign surety for the loan in your personal capacity, even if you meet their criteria. This then opens up everything you own to being attached by them if you default on the loan.
When borrowing from individuals, though, you should still approach them in a business-like manner, and treat them with the same respect you would the bank. This means:
1. Giving them a well thought-out business plan, that shows you've thought about all the angles and done your research.
2. Respecting their decision if they choose not to invest with you, or invest less than you want.
3. Never, ever, ever mess them around with repayments. Keep your promises to the T. You wouldn't ever dream of messing with the bank, would you?
I've raised money like this on a few occasions - with great success for both myself and my investors. I've managed to build up my reputation for people to trust their money with me, and the way I approach them is to offer them a rate of interest which is more than they would get on a low-risk investment (like a money market account), but one that's lower than what I would get from the bank. Say, for example, they have some spare cash and could get 8% at the bank on it. The bank is offering to lend to you at 16%. Offer your investor 12% - it's a win-win...
Gareth |