October 1, 2018 | Last Updated on: August 1, 2023
A sole proprietorship is the most common legal structure for new businesses. It’s also the easiest to set up, which is why many entrepreneurs choose this option by default. However, as the sole owner of your company, you are responsible for all debts, losses, and liabilities that occur. So how does this affect your ability to get small business loans, and is there a way around it?
A sole proprietorship is a legal structure that your business entity is registered under. For legal and tax purposes, it means you are the sole owner of your company. It also means that the business owner and the businesses are one and the same. This way, the business’s income and assets all belong to you – the owner. The downside is that as a sole proprietor, you are also responsible for any debts incurred by the business.
How Sole Proprietorship Affects Financing
A sole proprietorship is the least complicated legal structure in which to establish your business. However, it becomes significantly more complicated when small business loans and grants are involved.
Put simply, operating as a sole proprietor narrows down your credit options. Why? Simply because lenders use your personal credit profile to determine whether you qualify for a loan or other line of credit. Of course, qualifying for a loan or business credit card may be easier if you have a strong personal credit score. However, you will usually need to sign a personal guarantee to secure the loan.
To apply for small business loans under a personal guarantee, you will need to commit personal collateral or assets to be approved. Signing a personal guarantee means you are solely responsible for any defaults that occur on your account. It specifically means any assets (such as your home, car or savings) could be seized to cover your loan if you don’t make the repayments.
Personal guarantees are legally binding agreements that allow the bank to hold you personally responsible if you default on the account. You also risk being held personally liable if your business is sued.
Borrowing money as a sole proprietor is often perceived as risky. Not only are you less likely to have a loan approved, but your personal assets could be on the line if you default. One option is to choose another business structure for your business. However, this is a complex process, and it isn’t always possible.
Luckily, there are other sources of financing available to sole proprietors. These include:
The Small Business Administration provides funding to businesses of all sizes and structures, including sole proprietorships and business loans for women. However, you can only borrow a maximum of $50,000, so you’ll need to use the funds wisely! The government guarantees SBA loans, so you don’t need to put your assets on the line. Instead, if you default, the bank gets reimbursed, so this is a relatively risk-free option.
“The Government’s Small Business Administration reports that small businesses represent 99% of all employers in the U.S. and are responsible for generating well over half of the new jobs created.” – Ellen Tauscher
Angel investors often provide financing to sole proprietors, especially those in the same community and industry. Angel investors will lend you money if they believe in your business and want to see you succeed. What this means for a business owner is that the angel investor will often take on a hands-on role, offering training, advice, or practical support.
To seek out an angel investor, you will need to network in your industry and prepare a solid business plan. All angel investors have different terms. However, you won’t usually have to sign a personal guarantee for your proposal to be accepted.
Big banks are the first place sole proprietors go when they need capital, but they are not the only place to get a loan. The private market is full of investors ready to lend money to small businesses; you just need to know where to find them! This is why networking is key.
Many private investors provide the same type of financing a bank would provide, including lines of credit and equipment leases, but without the requirement of a personal guarantee. It doesn’t matter if your credit isn’t great or that you’re the only person responsible for paying back the loan. If a private lender believes in your business idea, they can be persuaded to invest.
Crowdfunding has become a popular way for businesses to raise money in the startup stages, and there are many success stories of companies who started this way.
If you have a great idea that you think will benefit the public, you can ask large groups of people to donate small amounts to the cause. Thankfully, the Internet has made crowdfunding easier than ever. If you get enough attention online, you could raise all the capital you need to get your business idea off the ground.
Crowdfunding relies heavily on good marketing, however, so you need to research your niche audience carefully and know how to target them. There are several ways you can utilize this form of financing, but you have to get creative. Try getting people involved in your business, offering samples, sending free products, and hosting competitions to get people excited about your startup.
The bonus of using this method of funding is that as long as you use the money as advertised, you won’t need to pay it back.
You may be able to find a peer-to-peer lending set-up in your local community, which works just like private lending, only with smaller loan amounts and more flexible terms. Peer-to-peer lenders also operate online, where you can be “matched” and enter into a partnership with an investor in your industry. Although, it is important to note that you want to be careful where you share your ideas and business information. However, a reputable P2P lending site can be far less risky than a bank loan.
Finding a business loan for your sole proprietorship can be challenging, but it’s not impossible. If you are serious about starting a business and becoming a small business owner, you need to put your business plan together and start marketing it to the right people. Eventually, your financing options will open up and your sources of capital will increase, but you have to be willing to research your options and understand the different types of funding available to you.
You can, of course, try the traditional bank route as a sole proprietor. A strong business plan might persuade some bank lenders, and not all will require personal assets to secure a loan. However, be assured that there are plenty of other funding options if you get turned away.
