How to Know when a Small Business Loan is the Right Choice
As a small business owner you will face many challenges as you grow your brand. If you hope to move beyond the local markets to something bigger, you’re going to have to compete with the enterprise companies out there, and that means more product or services, more employees, and possibly a bigger office or warehouse—and this all takes a bigger budget. If you don’t have the capital, you’ll likely have to take out a loan.
One of the more difficult decisions for many small business owners is how to know when taking out a small business loan is the right choice.
When Is a Loan a Bad Idea for Small Businesses?
For the most part, questioning whether to take out a business loans is the result of good things happening for your company. On the other hand, loans are rarely a good idea when business is slow or new products didn’t create quite the splash you had imagined.
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Applying for a loan is not synonymous to getting a loan. The application process is usually quite long, the conditions you must meet to qualify are almost endless and, of course, you risk losing the collateral you put up—namely, your business—should you be unable to repay the loan.
The problem with getting loans in poor economic times (for your business, that is) is that this isn’t always the most rational moment for business owners to make the huge financial decision to pursue a loan. When emotions or fear is involved, it can impair your ability to be impartial enough to make a rational choice.
It may work out in your favor, but the risks demand that you step back until a cooler head can prevail in order to truly do what’s best for the business.
When Is a Loan a Good Idea for Small Businesses?
Now that you understand when a business loans isn’t a good idea, it’s time to consider when it is good for your business. The following situations are excellent indicators that your business might do well to consider a loan—some are for fast infusions of cash, born of temporary needs, others are about future planning.
Below are a few scenarios when businesses are usually well-served by taking out loans:
1. To Build Your Business Credit
You may not need the cash right at this moment, but if business is going well, you’re probably looking well into the future. If you estimate that soon you’ll need to make large purchases like new equipment, physical expansions (in terms of office, retail or warehouse space), or updated technology, a loan is warranted.
In addition, obtaining and, most importantly, rigorously repaying small loans on time right now will build up your credit score. If you are a new or small business without much of a credit history, this will be a definite advantage for when you are ready to make a bigger change for your business that requires a bigger loan.
2. To Jockey for Better Loan Terms
For businesses that received loans in the aftermath of the Great Recession—a time when terms were notoriously slanted in favor of banks rather than the businesses they served—now is a good time to refinance or take out new loans in order to pay off the old debt. Depending on the terms of the existing loan, the interest rate, etc., you could save a lot of money on interest while making lower monthly payments.
Of course the Great Recession isn’t the only reason for less than favorable existing loans. Business owners who took out loans before the business was well established may have gotten loans with higher interest rates, too. Eliminating the bad loans and replacing them with new ones that reflect your current credit worthiness can also save your business a great deal of money in interest.
3. To Expand Your Property
Growth is almost always a good sign for businesses and a solid reason for getting a loan. When you’re doing so well that your business is literally bursting at the seams just to accommodate your employees or physical inventory, you may decide to expand your property. Or maybe it’s time to open a second or third retail shop or restaurant. Just because business is good, though, doesn’t necessarily mean that you have the ready cash to make this expansion.
Keep in mind, however, that small business owners need to run a revenue forecast to ensure that they’ll be able to bring in the additional revenue to pay back the loan and turn a profit.
4. To Buy New Equipment
Whether you’re upgrading existing equipment and technology or investing in new equipment and/or technology for your business, loans are a great way to make that happen. In some cases, the items themselves will serve as a large portion of the collateral, which will create a more receptive lending situation with the banks. Provided, of course, that your income and creditworthiness are sufficient.
Advantages and Disadvantages of Small Business Loans
As with many things in life, there are advantages and disadvantages to securing loans for your business. Some of them are more obvious than others and some of them are unique and individual to your business.
Advantages of Small Business Loans – The biggest advantage for many business owners is that interest rates are currently extremely low. After the huge scare of the Great Recession in 2008, banks are finally finding the courage to lend again. This largess is resulting in better terms and interest rates for businesses, so if you see a need for a loan in the next couple of years, now is the perfect time to start working toward that end. If you wait one or two years to get the loan, your terms aren’t likely to be as favorable.
The advantage of applying for a small loan for your business now is that even if you are rejected you’ll still receive an idea of why and what you need to do in order to make your business more attractive to lenders. Some business owners are afraid of possible rejection, but the truth is that rejection is a natural part of business, so as long as you use it as an opportunity to grow and learn it doesn’t represent the sum total of your business.
In addition, as long as you’re a corporate entity, taking out a business loan won’t put you at risk personally should you default on it. If you are unable to repay the loan, your company will be liquidated in order for the banks to reclaim their money.
Disadvantages of Small Business Loans – There are a few disadvantages to consider as well. The biggest downfall is interest. While today’s interest rates are remarkably low, you must still pay interest on the money you borrow from lenders. Plus, not all terms are favorable to your business, so it’s important to look at all sides of a loan before signing on the dotted line.
Another disadvantage is that many business loans require a certain amount of collateral before they are approved. Small businesses that are just getting started or do not yet have a great deal of real property to provide as collateral may find this overly restrictive. For some, it makes the possibility of receiving a small business loan impossible.
Finally, there are the terms. Take the time to make sure you understand the loan terms before agreeing to them. If you don’t understand them, ask for clarification until you do. Never agree to terms before you fully understand their potential ramifications.
This includes things like:
- Ability to Re-negotiate for Better Terms Later
- Customer Service Expectations
- Flexibility of Payment Deadlines
- Frequency of Payments
- How Interest Will Be Calculated
- Penalties of Missing Payment Deadlines
Alternatives to Small Business Loans
Before you decide for or against a loan, it’s also important to realize that one bank does not represent them all. There are other lenders out there who may be happy to do business with you.
Additionally, keep in mind that small business loans are not the only option you have available to you for fast infusions of cash. Unless your reason for getting the loan is an opportunity to build future credit, other options might be better suited for your business needs, such as:
- Community Grants – Many states and local communities offer small grants to business owners in order to attract and keep businesses in the community. You may have to jump through a few hoops to get the grants, but many of them fall in line with what business owners are looking for when applying for loans.
Another thing to keep in mind is that the grants are generally insufficient for major expansion projects or equipment overhauls, but they can help ease the pain of a slow season or help with small improvements or upgrades to your business.
- Crowdfunding** – Crowdfunding is still a relatively new concept for businesses, but platforms like Kickstarter and Indiegogo have been instrumental in getting countless businesses and/or products off the ground. And as of 2012, when the JOBS Act went into effect, business crowdfunding is now available to support small business growth and entrepreneurialism.
Products like Goldiblox and the Pebble Smartwatch got their initial funding on Kickstarter. The Small Business Administration also recommends that you consider online financing through non-profit lenders, invoice financing, and loan matching sites in addition to the types of crowdfunding mentioned above.
Today’s business climate offers small businesses, like yours, greater flexibility than ever when it comes to securing the funds you need to start, grow, and further expand your business. But knowing when it’s the right time to take out a business loan is half the battle and can make a world of difference for your business in the long run.
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