Borrowing makes the most sense when you are making a good investment. Often, an investment can only be judged as good or bad with hindsight. Nevertheless, you can find ways to choose your risks and improve your chances. When borrowing for your business, you will know better than anybody how much risk you are taking.

Business or Pleasure?

Business loans help small-business owners get things done. You can buy materials, pay employees, and much more. Without a loan, you often can't get your product or service out to paying customers. If you need a business loan, what do you do? The first idea is typically to ask a bank for a loan. While it makes sense intuitively, you should also consider the bank's perspective. For them, you could be a brand new business with no (or very little) operating history, no employees, and no clients.

Most banks are very conservative. They have an extreme fear of losing money. If your business is too small, it might be too risky. A solution, in the bank's opinion, might be to make you personally liable for the loan. Because the business may not have assets to pledge, history, or revenue, the bank can't expect much from the business. You, as an individual, might be more likely to pay. Therefore, don't be surprised if the bank asks you to be personally liable for the loan.

Many small-business owners (and potential small-business owners) find themselves asked to lay their personal credit on the line. Once you become personally liable for a loan, everything changes. The lenders know they can come after you for repayment, even if your business goes belly-up. They have insight into your past payment behavior through your credit history. Furthermore, they know that the threat of messing up your credit will encourage you to repay the loan no matter how your business does.

Signing on personally might be your only option. If you have exhausted every resource available, you might have to decide between a loan or no loan. If you must sign on personally, consider the risks you take for yourself and your family. Granted, running a business is always risky to some extent, but your credit score does not distinguish between money you squandered and money from a business venture that didn't work out. You have to pay it back if you are personally on the loan.

A Credit Card and a Dream

Some businesses take off and are wildly successful. Occasionally, you hear of somebody who started out by maxing out credit cards and not really knowing what they were doing. While this is possible, it is risky. If you are up for the risk, that's fine, but there are less risky ways to raise money.

One way to get money is to sell a portion of your business. This is technically not borrowing, since the buyer gets an ownership interest, but it does place the risk in the buyer's hands. If the business goes under, you don't have to pay the money back.

This type of arrangement has its pluses and minuses. The main drawback is that you give up some ownership if the thing takes off, and you might even have to follow some rules set by the buyer. To find this type of arrangement, look for angel investors or venture capitalists. They might look at a business that the banks won't touch, but they want something in return. Note that it is quite difficult to find this kind of funding. You'll need to do a lot of legwork, preparation, documentation, and you'll need to sell your concept.

Another way to manage risk as a small-business owner is to use a franchise. If you don't have your heart set on starting things from scratch, you could find a franchise that you're interested in. The reason franchises reduce risk is that the selling company has already taken a lot of the risk. They figure out how to do things, how to market, which markets are good, and more. Success rates for franchises are somewhere above 80 percent. Contrast that with non-franchise businesses, where the failure rate is closer to 80 percent.

Most people think of food and restaurants when they hear about franchises. While there are plenty of big-name restaurants that use a franchise model, you can get into other lines of business as well. All you are doing is buying a business model from somebody. That model can be for hamburgers, handyman services, sandwiches, or staffing.