Using a Personal Loan to Start a Business in South Africa

If you are looking for funding to start a business, a personal loan might be your only option. Here is why.

When starting a new venture and you are looking to raise funds you will have two main choices: debt or equity. Which means you either have to take a loan or sell shares in the business. The economic value of a new idea is nothing and thus capital is hard to come by as starting a new business is a high-risk endeavour especially in a country with a challenging operating environment like South Africa. That is why equity deals are hard to come by as you need a track record and connections for someone to invest in you and most private equity firms work via introductions only (someone connected needs to vouch for you). It makes sense as they don’t know you, I mean you could end up just wasting the money.

South Africa also does not have an investment ecosystem (or education system) like in the US where private equity in startups flourish due to the potential of a single bet producing a billion-dollar home run. South Africa also do not have tax-payer-funded funds that provide grants or unsecured high-risk loans. In theory it does, but chances of being a beneficiary are so slim it is the equivalent of the hopes and dreams of playing the lottery. You will be sent from pillar to post.  You better off just forgetting about it and trying to make things happen on your own.

As for those pinning their hopes on a business plan. What you need to know about business is that business plans are useless, it is not worth the paper it is written on unless it can be executed upon and entrepreneurs often hire people to write plans or even worst download plans from the internet (and thus often don’t even understand the business plan). Even though it is often asked for, business plans carry very little weight. I have never seen an investment being granted solely based on a business plan (with the owner having no credentials).

In South Africa most business loans require collateral, all startup loans require collateral. If you have an existing business (and cashflow) you can use a debt instrument like a  notarial bond to fund your “plant and equipment”.  All property is secured by the title deed and vehicles via titleholder in the name of the lender to specify that that asset is collateral for a loan. There are other high-interest options for businesses with cashflow such as “retail capital” but outside of an emergency, they cannot be used as a working capital tool due to high interest rates. However without cashflow and a trading history all those options are off the table.

Startup founders then face a dilemma: savings, friends & family, or a personal loan.

Now before I continue I want to tell you something as someone that has lived under both the National Party and the ANC, in South Africa there are no good choices. You choose the less bad option. With business finance, it is no different. Not everyone has savings and not everyone has friends and family that will lend them – but even if they do, money often complicates relationships especially in a risky venture such as a new business. This leaves the last option: an unsecured personal loan.

Now even this is not a good option but sometimes it is the only option. You will need an existing source of income (such as a stable job) and unsecured loans have higher interest rates than comparable secured loans with collateral attached. If you take out a R10 000 loan over 12 months you must be prepared to pay back up to R1200 a month (x12), times that by ten for a R100k loan. This is the reality once initiation and service fees are tacked on. Why it costs R69 a month for “admin” for bits in a computer on top of a high interest rate and a R1000+ “initial admin fee” I’m not quite sure but this is reality. You can light a candle or you can curse the darkness. At least if you take the risk you don’t have to worry “what if” down the line.

A personal loan is a loan taken out in your personal capacity and can be used for many different purposes (not just to buy a specific item), it is often unsecured (you don’t need collateral, although collateral will make the interest rate cheaper), it comes with much more stringent approval requirements which is usually a clear credit history (not “blacklisted”) and need to meet affordability criteria. A personal loan is provided as a lump sum in which installments have to be paid back over a certain period.

This tells you that the person will fall into a very specific category, they or their partner has an existing job. But it also tells you it is likely to be money that they can (almost) afford to lose as the person needs to meet certain affordability criteria (they will need to have excess money). This means that the business will meet two of the most important criteria: it is money they can afford to lose and a realistic amount, that is their bird in hand what they have right here right now. They are miles ahead of the dreamers looking to raise millions . This also means they will (or should deploy that) capital responsibly as in only buying what they need and not spending on frivolous things.

If that business is to succeed its profits have to exceed the interest rate and repayments of the loan. What business matches these criteria?