As of 2018, there were 30.2 million small businesses, which account for 99.9% of US businesses.
If you are a small business owner, you’re in good company. Yet, small businesses are at risk of making small business financing decisions that ruin their ability to stay in business.
Read on to learn what mistakes to avoid when financing a small business.
Borrowing More Than You Can Afford
When you are starting your small business and you several business financing options, it is tempting to borrow more than you can afford. Especially because you don’t have many checks coming into accounts receivable yet.
But, borrowing more than you can afford is a huge risk. Not only are you risking too-high payments. But you could ruin your company’s credit and your own!
Even when lenders are willing to give you more, borrow conservatively. Stick to the numbers you’ve calculated you’ll need for your startup costs.
This way, you’ll pay less interest and build up your business credit score as you pay down your loan quickly.
Then, down the line when you have an expansion or a new project, you’re more likely to get a better rate on a new loan.
Ignoring the Hidden Fees
A loan is a loan is a loan, right? Wrong!
Lenders often stick additional fees into their fine print. Contract fees, application fees, administrative fees and so on can add up to 3-4% of your loan amount.
Those fees can make a big difference to how much interest you have to pay.
Whenever you borrow money, go over the fine print thoroughly. Always be well versed in the fees that go with the loan amount.
Not Shopping Around for the Best Offer
You might be thrilled that a lender is willing to give you a loan that you jump at the offer. But that’s a rookie mistake.
If you have great credit, you should contact a few lenders to see what they can offer you. Different lenders may give you better terms or a lower interest rate.
Even half of a percent savings on interest can equal big bucks over the term of the loan.
Exploring all your lending options to find the right one for you is a wise move.
Not Having Skin in the Game
Why should lenders take a risk on you if you aren’t willing to take a risk on yourself?
Lenders are more likely to fund you if you have something to lose. In fact, various types of business loans demand collateral to mitigate the lender’s risk.
This could be real estate property, cash or something else.
Waiting Until You Need Cash Fast
Financing a small business means planning ahead. It is easier to get a good loan when you are in a good financial situation. You can expect longer repayment terms and a lower interest rate.
When money is tight, your business poses a bigger risk to potential lenders. They protect themselves by offering you higher interest rates and shorter repayment timelines.
Or, if you leave it to the very last minute you may be forced to go to lenders that specialize in quick loans. These lenders usually don’t offer as favorable terms as you could get if you’re not in dire need.
If you foresee that you could need a loan in the near future, start the application process sooner rather than later.
Not Considering All Your Options
Financing a small business doesn’t have to come exclusively from a bank.
Credit unions, small business grants, Kickstarter campaigns and loans from family and friends can all help fund your small business.
Just be sure to set up a repayment schedule and stick to it when borrowing from friends and family. Otherwise, your relationship could take a hit.
Not Having a Business Plan
A business plan is a blueprint for the future of your small business. It should outline your goals, target market, your competitors and marketing plan.
A business plan should also include your projected revenues, bios of your executives and should outline the products and services you offer.
A business plan can help you in two ways. first, it will help you see exactly how much money you’ll need.
Secondly, it is a tool that works well in helping you secure funding from lenders. Your lender wants to see that you know what you are doing. A business plan helps lenders see where and how their funds will be used.
If you don’t have a business plan, it’s not too late. You can hire someone to draft your business plan for you for an hourly rate. Look for a business plan expert on freelancer sites such as UpWork, Freelancer and Fiverr.
You can also find software that includes sample business plans that you can use as a guide to help you get started with your business plan.
If you want to get the highest-quality loans such as an SBA loan you must have a business plan.
Too Many Overdrafts
Cashflow is essential for any business to survive. Overdraft protection should be your backup parachute, not the parachute you rely on.
Lenders interested in business funding take a look at your bank statements to see if you are in the black at the end of each month.
If they see various insufficient funds charges, they are less likely to give you the loan you’re after.
Being a small business owner can stretch you thin. Remember, you don’t have to have the skills to do everything in your business.
If overseeing incoming revenue and expenses is not your forte, it’s a good idea to hire an accountant that focuses on small businesses.
Lack of Cash Reserves
This mistake follows along the lines of too many overdrafts. Lack of cash reserves reduces your business financing options.
It’s crucial for small businesses to have sufficient cash reserves. This safety net will be there in case you need money immediately.
And it saves you from having to apply for an instant loan which can hurt your credit.
Having a personal cash reserve is just as important. When your small business is just getting off the ground, you’ll likely not be getting the paycheck that you deserve (or need).
Having personal savings while your business grows will help keep your personal finances in good order.
Having Insufficient Insurance
A large part of smart business financing is making sure that your business is adequately protected.
One of the worst small business financing mistakes too many people make is not having the right small business insurance policies.
Your insurance needs to include auto, health and liability insurance. Also, if you have employees, you may need to set up insurance plans for them to be.
Having Multiple Business Loans
Having multiple business loans is rarely advisable. Especially if you are taking out a new loan to pay back an existing loan.
The only situation where this is a good idea is if the new loan is cheaper and you’re basically just transferring to a new lender.
Remember, paying off a loan with a loan isn’t really a loan repayment. And, the more you borrow the less real revenue your small business has.
Lenders are wary about giving out loans to businesses with multiple loans. So these various loans could hurt you down the line.
If you are in an unsuitable loan or have stacked loans, you should consider business debt refinancing.
Neglecting Your Business Credit
When you start a small business, your personal credit is instrumental. But eventually, you want your small business to qualify for credit without relying on your personal credit.
It will take time for your small business to get there. So you should do everything you can to help.
This means trying to register your small business with a business credit bureau. Also, always use your business number for financial transactions.
Above all else, pay your business bills on time. Then, over time, your business credit will grow.
Relying on Financing Too Much
The thought of your business not making money is terrifying. Unfortunately, it’s a real threat to new small businesses.
Small businesses have a 50% chance of still being in business past year five. These alarming statistics make many small owners rely on financing to feel better about the current state of affairs.
But, making your operations run with financing means that your business can’t stay afloat without loans. You can see how self-reliant your business is by comparing how much money you bring in versus the amount of debt you have.
This is called your debt-to-equity ratio. Lenders look at this ratio before approving you for a loan. You can use this ratio to see if you are relying on financing to get you through from month to month.
If you are, you may need to look at expendable expenses or changing your operations a bit to balance the ratio until business picks up.
Final Thoughts on Small Business Financing
Thanks for reading. We hope that by reading about various small business financing mistakes you can avoid them and help your company succeed.
Remember, small businesses are the lifeblood of communities. Thriving small businesses improve local property values and stimulate the local economy.
Next, learn how to recover from a missed milestone in your small business plan.