Timing is everything, right? When it comes to running a small business, the timing of business decisions can make or break it, and nowhere more than when taking out a small business loan.
If you take out a small business loan too early, before your project or plan starts generating revenue, you will be making payments before you see a return. This could delay your ability to get the project going. Also, if you rush into taking out the loan, your financial plan could have flaws in it that you did not have time to identify.
Taking out a business loan too late could mean that you miss out on that great deal on new equipment, or your struggles with cash flow are insolvable by that point. You could struggle for too long to make ends meet, your financial situation could deteriorate and by the time you apply for a loan you might not be able to qualify. Particularly if you already purchased the large capital asset.
Like Goldilock’s porridge, you want your timing to be just right. Slightly before you need the money or plan on purchasing the asset, with enough time to settle the loan and receive the capital. The business funding should align with your business plan and budget, particularly if there will be a period of time when you will have to make payments before the capital generates new revenues.
So, given the importance of timing, when should you take out a small business loan?
All the tables in your café are full, and you consistently have a waiting list. Your designers have come up with a great idea for a new product, but you will need money to develop it.
The reasons to expand vary; to increase product or service visibility, hire key employees, to meet increased demand, or to upgrade or update facilities or equipment just to name a few. But, any needs resulting from wanting to expand can almost always met by borrowing. It is difficult to impossible to meet them from existing cash flows.
Taking out a business loan for expansion is always the right time if the numbers make sense. Calculate your debt service ratio currently and then what it would be if you took out a new business loan. Divide your net operating income by your total debt service to get this ratio, and don’t forget to add the new revenues you expect the loan to generate to the net operating income the second time you calculate it.
Note that if you have already mismanaged funds, maxed out credit cards, and are not in good standing with your lenders, adding more debt to the problem is probably not the solution. A small business loan is not a good stopgap for a business which is otherwise failing. Instead of applying for a loan, your time would be better spent learning budgeting and financial management skills. If you are taking a business loan your focus should be how the new funding helps you do more business or make more money.
All businesses have slow times, particularly if you operate in a seasonal industry. A business line of credit helps small business owners keep running when cash flow is tight. It can be drawn on to cover business expenses during the off season and repaid when cash flows have picked back up.
While you could cut expenses during a slow period, the long-term ramifications of this could harm your business. Lay-offs in the short-term lead to being under-staffed when you need support. Slashing prices could lead to a customer expectation that they will always receive a discount, hurting future sales.
If you anticipate or know that your business will go through a slow period, apply for a business line of credit ahead of time. Often, you will pay nothing or just a small fee to keep it open if you have yet to draw on the funds. Shield Funding does not charge any hidden fees on a business line of credit, and it is available for borrowers that have credit scores of 650 and above. If you have poor credit and still require a cash flow cushion a bad credit business loan can be a great alternative. Alternative lenders can be an excellent choice for a small business owner who has less than stellar credit.
Business at your new bakery has been booming, your reputation has spread, and several local restaurants offer you their bakery contracts. The problem is that you know your existing equipment cannot produce enough to meet their production needs. Sometimes opportunities will arise that force you to decide – stay at your current level, or borrow in order to capture a new business opportunity and reach the next level?
It is the rare business owner that does not want to grow and build upon past successes. If you turn down a great opportunity it could be a while before it comes your way again. It might be time to borrow, whether in the form of equipment financing or a term loan, and modify your existing business plan.
The right time to borrow could be sprung upon you when a fantastic business opportunity drops in your lap, and the right business loan could enable you to seize that opportunity.
When your business was newer, and your credit score lower, you might have taken out debt at higher interest rates or with unfavorable terms. Many traditional lenders look at the amount of time you have been in business when lending, and will not lend to businesses with a history of less than two years. While alternative lenders will lend if you have only been operating for two months, your rate will reflect your risk.
When your business has been showing strong revenue growth and your financials have improved, it might be the time to re-finance that older debt. A lower interest rate could lead to a lower monthly payment, freeing up cash to run and expand your business. Consolidating business loans into one payment simplifies your financial management and often reduces the overall costs associated with the debt. Consolidating older debt into a new business loan can improve your business’ operations.
However, slow down and analyze your options if you are making an impulsive decision to re-finance debt. That shiny new, lower interest rate could be offset by some hefty fees. And those fees could wipe out any cost savings from the re-finance. Also, check that older business loans do not come with prepayment penalties.
Small business owners with good credit will receive the best borrowing rates and terms. But, oftentimes, the financial choices you make to get your business off the ground harm your credit score. Or, you do not have much personal or business credit if yours is a primarily cash-based business. There are benefits to taking out a small business loan even if the business does not have a pressing need for the capital. It will build your credit for the future.
Let us say that your business plan leads to a need for a large loan in five years to open another location. If you know that you will need access to credit in the future, you might want to take out a much smaller loan now. It will establish a relationship between you and a lender, prove that you can manage and repay debt, and can be part of a credit repair strategy.
It might be the right time to borrow now in anticipation of future borrowing needs.
New business opportunities can land in your lap, or you can go out and find them. If you have been interested in expanding, perhaps to another location or adding another product line, look into an acquisition. There are business specialists who help large corporations identify acquisition targets, but a smaller business owner can do the research themselves.
Is there another restaurant in town, similar to yours, whose owner might be close to retiring? A company who manufactures a product similar or complementary to your main product line? The owners of those companies might be open to talking to you about an acquisition.
Combining resources and absorbing a smaller competitor is great for growth. You will have numbers and financial statements from which you can determine the value that the acquisition will add to your business. If the advantages outweigh the cost of capital, it is an excellent time to take out a small business loan to fund the acquisition.
Similarly, you can take out a private business loan to purchase the assets of another business. The reality is that businesses fail, or their owners are unable to find a buyer before retirement, or for whatever reason they close their doors. Liquidation companies sell off their assets at significant discounts, which is your chance.
Because it serves as collateral, equipment financing loans require information on the equipment to be purchased. With a liquidation sale, you might not have time to provide a lender with these details and wait for approval. A business line of credit could enable you to snap up another business’ assets at a premium.
Traditional lenders require years of business financials, alternative lenders will lend to a business with only two months of operations if their revenues are high enough. If your business has not been operating for at least two months, you will not be able to obtain financing. A personal loan or startup business loan will help you launch your business and get it off the ground.
With a personal loan, a lender will look at your credit history and possible collateral. If you have poor personal credit, work on improving your credit score or see if you can find a co-signer.
Borrowing in a rush, or under pressure, can cost you in the long run. Another lender might have given you better terms, or a lower interest rate, if you had taken the time to shop. Do not borrow until you have thoroughly reviewed several lenders and done your due diligence.
This includes speaking to somebody who understands finance, such as an accountant or financial advisor. Prior to even applying for a small business loan you should have a clear idea of how the loan servicing will impact your business. This includes calculating your debt service ratio, evaluating your financials and free cash flow both before and after a loan, and weighing the investments’ potential return against its risk.
A huge component of all these calculations will be the lender’s fees and terms. If you can perform this math on your own, great. But many small business owners are experts in other areas of running a business and would benefit from bringing in a professional to help them in their due diligence.
Is there ever a time when you should not take out a small business loan? The deal may be tempting, but it would be the wrong choice for your business. Or, you are moving too quickly and have not thoroughly evaluated the loan’s impact. Here are a few times you should say “pass” to an opportunity that would require borrowing.
A Risky Venture
If the project has no clear goals or projections, it is not a good idea to go into debt to pursue it. Just because something looks like a good opportunity, doesn’t mean that it is. If you cannot calculate the return on investment, if the numbers are fuzzy or there are no numbers, take a step back.
If you’re going to put your business’s credit on the line, and take on thousands of dollars of debt, you need to be sure this is going to yield long-term value for your company. While you may not have exact numbers, you should at least have estimates of the costs and potential revenues involved.
If all your current loans and lines of credit are maxed out and you’re still having trouble, taking out yet another loan probably isn’t the solution. You cannot put a Band-Aid over a failing company or poor financial management. Instead of taking out another loan, you may need to attend some business management classes or talk to a financial advisor.
And if you are already maxed out, the new loan will likely be at a higher interest-rate and less favorable terms. Consolidating debt can eliminate headaches, true, but if it is at worse terms it will cost you more in the long run. Better to buckle down, cut costs, and pay down the cheaper debt.
If you have not had time to analyze the business deal or obtain all its financials, do not move forward. A seller who is pressuring you, mentioning other bidders or other interested parties, enforcing arbitrary timelines or putting forth ultimatums, could definitely be hiding something. If you do not know the ins and outs of what the debt may yield, walk away.
It is better to let an opportunity pass you by than to wind up in a bad business deal. Numbers and analysis remove emotions from the situation, and bypass high-pressure sales techniques. The same rules apply for a lender who is pressuring you to take out a loan and hand-waving any concerns.
If you think your business might be at the point where it needs a capital infusion, compare your situation to these reasons above. They could help you solidify your instincts, and lead you to take action. If you know that you are ready to borrow, pick up the phone and call a qualified small business lender today.
