What are the bad sides of small business loans?

As of 2009, small businesses employed half of the people in the private sector and accounted for half of all production in the U.S. People starting a small business may contemplate a small-business loan, but this carries significant risk to the health of the business and your personal assets.FunctionSmall-business owners who take out a loan must eventually repay the principal and interest even if the business fails; unlike stock, where the investors bear liability if the company falters.

Interesting FactSmall businesses can prove very risky for the lender in troubled economic times. In February 2009, small-business-loan defaults hit 12 percent, compared to 2.4 percent just five years earlier.

ConsiderationsLoans usually enter repayment during the formative years of a small business, a time when having liquid cash on hand is crucial to the company's future success.

EffectsFuture investors and lenders see increasing debt levels as signs of a financial troubled company. In addition, some small-business loans include caveats that prevent certain company activities, such as finding different sources of funding.

CollateralMany commercial lenders require some sort of collateral (an asset put up to guarantee the loan). If a person fails to pay back the loan, they could lose the business and other property they may have used as collateral, such as a house.

Source:Debt vs. Equity: Advantages and Disadvantages

CNN Money: Small Biz Loan Failure Rate Hits 12%

Raising Money for Your Small Business: Loans vs. Equity Investments

More Information:Federal Reserve Bank of San Francisco; FRBSF Economic Letter 2009-07; February 13, 2009