Why Startup Loans to Address the Access to Capital Gap Are a Terrible Idea

I’ve written about the access to capital gap for minority and female entrepreneurs before here and here, so you likely already know where I am going when I say that startup loans to address the access to capital gap are a terrible idea, but I think it’s so important that it warrants its own post. 

Again, yes, much of the performance gap between white, male owned businesses and female and/or minority owned businesses can be attributed to disparities in startup capital because it’s much less likely that entrepreneurs from these groups can access the checkbook of the literal or figurative rich uncle. But startups are incredibly risky and, if a new entrepreneur is someone who has very little money and low or no credit, a small business loan to launch a business is likely a really bad idea. Most businesses fail and this person will not have a way to pay back this loan if their business does, so they’ll only have further damaged their credit and financial situation. If a borrower is in a financial situation to be able to handle the loan payments even if the business tanks, she’s also likely in a position to be able to save and self-fund instead of taking on a risky loan.

Yes, there are some specific situations where a very small startup loan could be useful. For example, if a new entrepreneur has pre-sold contracts but doesn’t begin to collect payment until she begins to perform the work. Signed contracts in hand don’t give her the money to buy what she needs to start work but there is a much higher level of confidence that she’ll be able to repay the loan because she already has signed contracts in hand that prove the demand for her service and help predict her early cash flow.

Alternatively, if an entrepreneur is looking to build a high-growth startup, as opposed to a lifestyle business, but lacks the ability to raise the typical family and friends round of funding, what we need is a source of equity capital or an alternative funding model, like revenue participation, not debt, which is inappropriate for this type of startup at this stage.

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