As the Manager of an SBA Microloan Program I work with many several startups every month who are looking for funding to start a business. In a recent blog post, “The Truth About How to Secure Funding to Start a Business” I outline a large number of financing sources for entrepreneurs looking for startup funding, but what I didn’t do was set an expectation for a fair interest rate that entrepreneurs should expect to pay for startup funding.
Depending on the source of funding, risk involved in the loan, collateral, term of the loan, loan amount, additional sources of income, credit score, and your business plan, you might expect to pay between a 6% and 25% interest rate.
You might think this is crazy since your mortgage is probably lower than it ever has been, maybe even in the high 3% range. Now I want to explain to you why interest rates for startup businesses are so high:
1. Startups Have No History – If you are requesting a loan to start a business, the lender is taking a HUGE risk. What if no one wants to buy your product or service? You have no history or sales, or cash flow, or profits. Lenders want to give you a loan based your current income, not future/potential income. This makes lending to startups incredibly hard.
2. Startups Fail – Many, maybe even most, startups fail. Most businesses don’t make it to their 5th anniversary, yet the terms for many loans may be 5+ years. If you think about the math for a lender it probably takes 10 good loans for every 1 bad loan for the bank to make a profit. When it comes to startups, far more than 10% fail, so the math simply doesn’t work to lend to startups at a low or even reasonable interest rate.
3. Entrepreneurs Need to Take Risk Too – If you are not willing to take significant risk as a business owner, then why should your lender? If you are not willing to put any of your own cash or assets at risk, then are you certain this startup business is going to work? Why are you so worried? These are all questions that your lender will ask.
If you are going to apply for a loan as a startup, you really need to have your act together. I would encourage you to have an expert like Brian from Optimus Business Plans review your plan before submitting to a lender.
About the Author: Adam Hoeksema is the Founder of ExecutivePlan. ExecutivePlan helps entrepreneurs write powerful business plan executive summaries in order to raise capital. Download Adam’s Executive Summary Template here.