7 deadly sins in borrowing money for your business
5 minutes read
Getting a business loan can be the fuel your company needs to reach the next level of success.
But you have to prepare yourself and your company to get the money and make sure the loan is right for you.
Joanne MacKean, Director, a Business Centre Manager at BDC in Winnipeg, has loaned money to hundreds of businesses for such projects as buying equipment, real estate and technology. She sees many entrepreneurs making these common mistakes that jeopardize their company’s future.
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Find out what banks are looking for in a loan application.
1. Borrowing too late
You may be tempted to finance your expansion projects from your cash flow. But paying for investments with your own money can put undue financial pressure on your growing business. You may find yourself needing to borrow money quickly and doing it from a position of weakness.
“When there’s a sense of urgency, it usually indicates to a banker there was poor planning,” MacKean says. “It’s often harder to access financing when you’re in that position.”
Solution—Prepare cash flow projections for the coming year that take into account month-to-month inflows and outflows, plus extraordinary items such as planned investments. Then, visit your banker and discuss your plans and financing needs so you can line up the funding before you need it.
2. Borrowing too little
You’re right to be careful about how much debt you take on. However, low-balling how much a project will cost you can leave your business facing a serious cash crunch when unexpected expenses crop up.
Solution—Develop a cash flow forecast for each individual project including optimistic and pessimistic scenarios. And then borrow enough money to ensure you can cover your project, unforeseen contingencies and the working capital required to bring your project to completion.
3. Focusing too much on the interest rate
The interest rate on your business loan is important, but it’s far from the whole story. Other factors can be just as important, or even more so.
- What loan term is the lender willing to offer?
- What percentage of the cost of your asset is your lender willing to finance?
- What is the lender’s flexibility on repayments? For example, can you pay on a seasonal basis or pay only interest for certain periods?
- What guarantees are being asked from you in the case of default? Do you have to pledge personal assets?
“There are qualitative items in a loan agreement you have to think through very carefully,” MacKean says. “Some entrepreneurs will skim over the loan terms and conditions because they think they’re just legal jargon or standard terms requested by all lenders. But the truth is that terms and conditions can differ greatly between lenders”
Solution—Shop around among financial institutions for the most attractive package, keeping in mind the importance of the terms other than the interest rate.
4. Paying your loan back too fast
Many business owners want to pay back their loans as quickly as possible in an effort to become debt free. Again, it’s important to reduce debt, but doing so too quickly can cost your business. That’s because you may leave yourself short of cash. Or the extra money you’re devoting to debt reduction might be better spent on profitable growth projects.
Solution—Compare your projected return on an investment to how much interest you’re saving by paying down your loan faster than required. If you expect to earn more investing the money in your business, consider slowing down your repayment pace.
5. Failing to keep your financial house in order
It’s all too common for busy entrepreneurs to let record-keeping and other financial chores slide—with potentially disastrous consequences. It’s essential to keep good financial records, including year-end financial statements. Messy financial records can leave you in the dark about how your business is performing until it’s too late to take corrective action. It can also make it difficult to approach a banker for a business loan because not only do you lack documentation, but you’ve also shown a lack of managerial acumen.
Solution—Be diligent about keeping financial records and spend the money to hire an accountant. Also, consider getting help from a consultant who specializes in financial management to get your business on the right track.
6. Making a weak pitch to your banker
You can see how much sense your project makes, but you won’t get far if you can’t persuade your banker to get on board. MacKean says too many entrepreneurs are unable to clearly explain their company’s business plan, past performance, competitive advantages and proposed project. The result is a polite “no, thanks.”
Solution—Prepare your pitch and practice it repeatedly. Focus on explaining your business and how you’re going to use the money you want to borrow in clear and compelling terms. Remember a big part of your sales job is persuading your banker to have confidence in your management smarts and ability to build a strong business (and pay back the loan).
7. Depending on just one lender
Having a relationship with just one financial institution can limit your options, especially if your business hits a bump in the road. “You don’t want one lender holding all the cards should something go wrong,” MacKean says. “So, just as you would diversify your suppliers or customer base, or your own personal investments, you want to diversify your lending relationships.”
Solution—Meet with other lenders and consider using different institutions for different types of financing products.
Get more advice to boost your chances of obtaining a business loan by downloading our free guide: How to Get a Business Loan.