As a kid I was always advised to pay cash for everything and if I didn’t have enough cash in hand, then I couldn’t afford nor buy it. Now many years later I have those words still ringing in my ear, but like the proverbial angel and devil that sits on each shoulder. I also have conflicting advice being whispered in my other ear: “You have to spend money to make money.”
As I struggled with a tug-o-war of whether or not to apply for a small business loan, I found out some interesting facts that I hope help you, too. Actually, most of this advice also applies to car loans, home loans, or other areas where you are considering borrowing money.
- Get your books in order. – Are you in the red or the black? If you’re turning a nice profit and have the numbers to prove it, then it might be the right time to expand and get some financing to increase your output. However, if you are in the red and need cash to dig yourself out of a hole, borrowing money may not be the best idea. Additionally, if you do take out a loan, can you make the monthly payments on what you are currently bringing in? While you may plan for an increased income down the line with your expansion, it may not happen instantly.
- Will the money bring in more profit and improve the customer experience? – If so, then a loan can be a great thing. According to small business advisor Vince Daines, “if you want to borrow money to buy a new lawn mower for your landscaping business, there’s little chance that the new machinery is going to be the thing that turns your business into a success… [However], if borrowing the money will give you the funds that you need to provide an extra service or make your current product line better, taking out a small-business loan can be a great idea as it will eventually lead to a greater amount of profit.”
- Know what kinds of loans are out there. There are basically five different types of loans that most entrepreneurs get:
a. SBA loans are available from the government and can be used to buy equipment, inventory, furniture, supplies, etc. You can go to sba.gov to find out about the different types of loans they offer and how to apply.
b. Line-of-credit loans are short-term and let you access a limited amount of money that’s deposited into your business checking account on an as-needed basis. For example, credit cards are this type of loan; you can access additional funds and then are charged interest on the money that is lent to you. Line-of-credit loans are usually limited to buying inventory and pay operating costs for working capital, but are not available for buying real estate or equipment.
c. Revolving lines of credit occur when a lender offers a predetermined amount of funding to a borrower and allows the same amount to be borrowed again upon repayment.
d. Family and friend loans are just that. While it may be appealing because of the low interest, it can also tear a relationship apart. Before asking a friend for money, get the specifics in writing including interest amount, monthly payment plans, and potential collateral.
e. Angel investors are the best friends of entrepreneurs. They usually partner with startups between the first and second years of a company’s establishment. However, angel investors aren’t just helping you from the good in their hearts. They typically demand equity, a high return on investment and a well-defined five-year plan in return.
4. Once you’ve decided on a loan, read the fine print. Know the specific terms of the loan including how much money will be lent, the length of time you have to repay the loan, how much you are paying monthly, the monthly due date, and the interest rate. Also crucial information is the delivery address for payments or whether you can set up automatic payments from the company’s business account. Furthermore, inquire about the repercussions if you happen to default on your payment. While you may not foresee this occurring, life happens and it’s better to know all of the risks before you sign on the dotted line. Finally, ask if there is a penalty for early repayment. Banks make money on interest and if you pay off your loan early, they lose a chunk of their profits.
But wait! You’re not done yet! Consult with your CPA, a business advisor, mentor, or business lawyer and get their advice on what is best for your situation. Do the rewards outweigh the risks, are there better options out there, and in a worst case scenario, are your assets protected? Know what you’re getting into before you jump in.