By: Karen Sams
Most businesses require some type of loan at some point. But borrowing can be risky, and the wrong decision can seriously damage your business. Read on for expert advice on the most common small business loan mistakes and how to avoid them.
The first step in acquiring capital is understanding the best loan to meet your needs.
“There are over 44 different types of financing available to small business owners, and not every one of them is right for each situation,” says Gerri Detweiler, head of market education at Nav in Sarasota, Florida. “The wrong loan can devastate your firm’s finances, so it’s worth taking some time to make sure you understand what will work best for your current situation.”
For example, credit lines can help with short term cash flow, but equipment should be purchased using longer term loans with collateral. Nav.com offers a reference chart to help small business owners better understand which loans to consider for different circumstances.
Cash strapped small business owners might be tempted to borrow money to cover payroll or even their own salaries. But this is a bad idea.
“That is just a Band-Aid,” says Bryan Clayton, CEO of GreenPal in Nashville, Tennessee. Clayton recommended small business owners make sure the funds will be used to fuel growth, not just maintain current operations.
“Ask yourself, ‘Why?’ five times when you’re considering taking on debt to run your business,” he says. “[If it won’t] fuel growth [and it’s just] to keep the lights on, that’s never a good idea.”
Just like consumer loans, business loans come with different terms and interest rates. Unfortunately, small business lenders don’t have to follow the same regulations that consumer lenders do.
“Small business lenders aren’t required to disclose the annual percentage rate like consumer lenders are,” Detweiler says. “Sometimes the cost of loans ends up being much higher than the business owner realizes.”
Detweiler recommends that small business owners educate themselves on how different terms can impact the total amount they end up paying. “Cheaper isn’t always better,” she says. “If you need money fast for a short term need, for example, you’ll likely pay more for it. But if it allows you to take advantage of a profitable opportunity that won’t be around if you wait, it may be worth it.”
On the other hand, if you have a long term capital need, you may need a lower cost, long term alternative such as a bank loan or SBA loan. Otherwise, high rates over an extended period of time could hurt your cash flow, Detweiler says.
While short term loans and lines of credit are often the easiest loans to obtain, they are also the most expensive. Rob Wilson, CEO of lending firm C7a in Freeport, Maine, urges small business owners to constantly evaluate their credit profiles to ensure their borrowing needs haven’t outgrown short term options.
“The tell tale signs you are ready for a longer term working capital loan is when lines or short term debt are being continually rolled over to maintain a permanent balance due,” he says.
Small business owners should be careful to avoid borrowing to mask deeper problems with operations or sales, Detweiler says. Think critically about whether a loan is really the best strategy for solving problems.
“Sometimes business owners look for financing to try to fix a problem that could be solved without taking on an additional financial obligation,” she says. “For example, maybe your cash crunch is really a sales problem, and you or your sales team need to focus on closing sales.”