Borrowing To Prosperity Or Poverty?
“Only morons start a business on a
loan” Mark Cuban.
Debt can end a business, career, marriage or the debtor's life. Though borrowing is part of life, some creditors are slave masters. If you must seek their service, do ensure you have a good bargain.
Debt can end a business, career, marriage or the debtor's life. Though borrowing is part of life, some creditors are slave masters. If you must seek their service, do ensure you have a good bargain.
Mark's statement is pretty hash but here’s the question: Is getting a loan your best business start-up option? Are you getting the right loan and
borrowing the right way so you do all you can to ensure that you are able to repay without failing to meet up on your obligations and still qualify for the next
loan you’ll need for the continued growth of your business?
Some entrepreneurs think that the only goal of borrowing is
to get a loan application approved or just to have some form of financing they can use. But it’s
bigger than that. It’s actually common for businesses to grow and then to need
additional capital to propel themselves to the next level. It’s also common for
things like debt and credit mistakes to stop them from qualifying for that
additional capital.
Here are the four biggest dangers of borrowing money the
wrong way when building a business:
1. Allowing Lenders to Take Too Much Collateral With a Loan
This one can be a bit difficult if you’re not familiar with
choosing the right bank to work with. Here are some questions to ask yourself:
Can you borrow the money you need without pledging any
collateral to the bank? Some banks require collateral on all loans; other
banks will extend certain types of loans or lines of credit without any
collateral requirements.
What is a reasonable collateral request based on the loan
you’re requesting? If you’re looking for millions of dollars for a large
expansion, you’re not going to get it without collateral. However, if you only
need N500,000 or N1,000,000 for working capital or financing some receivables,
you’re an established business and you’ve got good personal credit, then you
may be able to get that financing without needing collateral.
You will need to work with a good person at the right bank,
but you get the idea.
2. Not Being Committed to Maintaining (or Improving) Your
Personal Credit
Although bank financing is challenging to get, it’s always
going to be the cheapest form of funding your business. There are “alternative”
financing options galore but it should always be your goal to get your business
to be “bankable.” In other words, you want to be able to obtain your loans and lines
of credit from a bank.
As a small business owner, your personal credit is normally
one of the key ingredients in the underwriting process to see if your loan
request will be approved. If you have excellent credit, maintain it. Don’t let
yourself get “too busy” to pay your bills on time. Don’t use your personal
credit cards for business expenses – this is possibly the biggest credit
mistake made by small business owners. If your credit needs improvement, then
be proactive about improving it. Your business will thank you.
3. Not Knowing the Impact of Your Loan on Your Budget and
Cash Flow
We would probably all agree that excessive debt is never a
good thing for any business. But what impact does the loan have on your budget?
There are two important factors here:
Use the funding you obtain for RGA (revenue-generating
activities). If you grow the business with your loan or line of credit, then
you’ll probably be able to justify the impact the loan has on your budget and
cash-flow.
Keep in mind that cash flow is
usually more important than interest rates. In other words, if you can extend a
loan from a three-year repayment period to four or five years in exchange for a
little higher interest rate, consider what lower payments mean to your budget
and cash flow. If that saves you $150 a month in the form of a lower payment
then it may be your best bet. If you end up growing faster than you project and
your cash flow is excellent, you can pay that loan off at an accelerated pace.
However, if your growth is slower than you expect or you have tight cash flow,
you’ll be glad you extended the terms.
4. Choosing the Wrong Loan for Your Purpose
Do you need a loan or a line of credit? Based on your
credit, business, industry, collateral, revenue, profit, etc., do you know what
your funding options are? If you understand what your options are, you can
choose the funding solution that’s best for you.
In conclusion, one of the two favorite words in
business: knowledge and execution. Know your funding options (most small
business owners don’t) and then execute. Period. Get your funding, use it for
RGA, and keep living the dream!
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