Borrowing money for your business is a big decision with long-lasting financial consequences. Before you apply for a business loan or sign a loan agreement, make sure you’re not making one of these eight common business borrowing mistakes.
1. Not having a firm grip on your business’ financial situation
This is the #1 business borrowing mistake from which all 9others stem. You should keep good financial records, manage your cash flow carefully, and at least learn the basics of bookkeeping. By regularly reviewing your financials, you’ll be able to make accurate financial forecasts and develop a long-term financial plan for your business—all of which enables you to borrow wisely.
2. Getting the wrong type of business loan
You should always match the type of loan to its purpose. If you need to finance commercial real estate, for example, you wouldn’t take out a business loan with a 12-month term. However, many small business owners take out long-term loans to pay short-term expenses, such as meeting payroll or buying inventory for a big order from a new client. Look for a lender that offers the specific type of financing you need.
3. Choosing the wrong lender
There are more borrowing options for small businesses than ever before, from the traditional sources such as banks and credit unions to alternative lenders and crowdfunding websites. Don’t rush into the borrowing decision: Take the time to assess all of your options before you apply for loans. Then, if you receive loan approval from multiple lenders, carefully compare the offers to make sure you’re getting the best possible terms.
4. Not knowing how much the business loan will cost you in the long run
With so many different financing options, it’s not always possible to compare apples to apples. It can be complicated to work out what various loan terms, interest rates, and payment plans will mean for your day-to-day budget. If necessary, have your accountant help you review the options before you make a decision.
5. Borrowing more than you can comfortably pay back
It’s tempting to borrow extra money just to have a cushion, but it’s not always wise. Make sure you can easily pay back any loan you take out by using your most conservative sales estimates. This knowledge not only gives you peace of mind, but also makes lenders more comfortable lending you funds.
6. Borrowing less than you need
Am I contradicting what I just said? Not really. Here’s what happens when you don’t borrow enough money: Before long, you’ll have to come back to the lender for more money because you’ve run out. The lender will (rightly) be concerned that you don’t know how to manage money and will be less likely to lend to you again. If you don’t develop accurate financial forecasts, you’re more likely to borrow too little.
7. Borrowing for things you don’t actually need
Many small business owners borrow money in order to purchase the latest equipment, lease a bigger location, or upgrade their technology. That’s smart if these investments will actually pay off financially, but not so smart if you’re going into debt just to “keep up with the Joneses.” It’s important to consider every business expense or investment carefully—and never more so than when you are borrowing to pay for it. Use your financial projections, run the numbers and make sure you’re confident a loan has good ROI before you apply.
8. Waiting until you’re desperate
It’s often said that banks only want to lend money to people who don’t need it, and there’s definitely a grain of truth in that when it comes to small business owners. If your business is struggling financially, banks will be concerned about your ability to manage money, and that makes it more difficult to get a loan. By managing your business finances correctly, staying on top of cash flow, and developing and using financial projections, you’ll be able to predict any need for capital well ahead of time, and apply for a loan before you’re in dire straits.