This guest post comes from our friends at Fundera
Financing is a necessary tool for most small business owners. Whether it’s a traditional term loan through the bank or an alternative funding solution, financing your business with a loan can be an accessible way to seize new opportunities, make it through difficult economic turns, hire new employees, and so much more.
But there can be downsides to business financing if you’re not careful. New business owners and seasoned entrepreneurs alike can easily run into pitfalls when sourcing business capital. If you miss an important step in the planning process, it can come back to haunt you later.
Of course, that shouldn’t scare you off from going after the financing you need for your small business. Simply take some time to learn from others’ mistakes—otherwise, you may repeat them.
Here are six business financing mistakes that are more common than you think, and easy ways for you to avoid them.
- Waiting until you need cash fast.
Many small business owners put off applying for business financing until they are in dire need of it. In theory, this makes sense—isn’t financing for periods when you don’t have cash on hand? Why bother applying for business financing when your business is financially healthy?
The reality, though, is that it’s much easier to get into a more favorable loan situation (i.e. one with a lower interest rate and longer repayment terms) if you’re in good financial standing with your business. And that might mean applying for financing before you need to use it.
Lenders that specialize in financing solutions with quick application processes understand that their borrowers can generally be more of a risk. Therefore, their interest rates are higher and their terms aren’t as favorable.
If you know that you’ll likely need business financing in the future, it’s a good idea to start the application process early.
- Not taking cash flow into consideration.
Some financing solutions are paid back on a more frequent basis than others. A merchant cash advance, for example, is repaid by deducting a certain percentage of your credit card sales every day. Some short-term loan borrowers have to make loan payments on a weekly, or even daily, basis, depending on their loan terms and conditions.
But what if there’s a disruption in your cash flow, and you’re having trouble making your frequent payments? In the case of a merchant cash advance, since the amount you pay is proportionate to your credit card sales, this isn’t much of an issue (besides the fact that you might be paying back your advance, and thus taking a hit to your daily cash flow, for much longer). But in the case of short-term loans, running low on cash and missing a payment can be dangerous for your credit score—and your business.
This is yet another hazard of waiting until you desperately need financing before you apply for it. If you need financing because you’re low on cash, you might be putting yourself in danger of not being able to make your loan payments—and digging yourself into a much deeper debt hole than you intended.
- Forgetting about hidden fees.
As with everything else in life (legally binding and otherwise), always read the fine print. Business loans often have hidden fees that business owners forget to take into consideration when applying for funding.
These can include origination fees, contract fees, application and other administrative fees, and more. Sometimes, fees are also deducted from the loan amount you receive, meaning you are actually going to receive less capital than your loan is worth.
There are also fees that are not-so-hidden, but that many business owners fail to consider. Maybe you don’t have an in-house bookkeeper and need to pay one on an hourly rate to process your loan—depending on the current financial health of your business, this could add up and make a big difference.
- Stacking your business loans.
Loan stacking occurs when a business owner takes out multiple loans at one time. While this can work out in the business’s favor, there are multiple situations where it is much less than ideal.
For example, it is almost never advisable to take out business financing in order to pay back other business financing unless the new financing is cheaper than the first. In other cases, it is asking for trouble—you’re not paying off debt, you’re just trading it off to a different lender. And it’s possible to have even more than one or two loans borrowed at the same time. But what some forget is that the more you have borrowed, the less of your revenue you actually have access to.
Additionally, lenders see businesses with multiple loans taken out as a risk, which could be harmful for you in the future. If you have multiple business loans or are unhappy with your current loan situation, you may want to look into business debt refinancing.
- Not having a business plan
If you’re serious about growing your business and want to be a contender for the highest-quality loans—like an SBA loan or a long-term loan—you will most likely need to have a business plan.
Not only will this help you and the lender gain clarity around your product and services, but you’ll map out a clear destination and path for growth. A business plan will help the lender understand how these funds will help you achieve a well-defined goal.
If you don’t have a business plan, you’re doing yourself, and the lender a disservice. They want to see that you’re responsible, stable, and know what you’re doing. Remember, they are investing in you and your business—so they’ll likely want to know where these funds will be going.
- Applying for a loan without checking your credit score first.
Finally, remember that when it comes to business financing, it more than pays to do your homework. That means having a realistic idea of what business financing solutions you’d potentially qualify for—and which ones you wouldn’t.
And understanding your options means knowing all the ins and outs of your business, including your credit score. You credit history is often one of the most important factors most lenders will take into consideration when reviewing your loan application. So before you start the application process, you want to make sure all the information lenders will receive is accurate.
For instance, if something is incorrect on your credit report that is hindering your score, you want to take care of that before you start applying. You’ll save yourself the major headache of having to explain an inaccurate report to a lender.
Additionally, you may have a lower business credit score than you think. Applying for a loan may result in a hard credit pull, which may actually lower your score—which really isn’t helpful if your score wasn’t high enough to qualify for the loan you applied for in the first place.
Staying on top of your credit means keeping your expectations in check. And don’t worry, there are many business financing options available for business owners with little credit history or bad credit.
Regardless of the type of funding you need, do your homework. Each of these mistakes is easy enough to avoid—and when the future of your business is at risk, you know how much it pays to be prepared.
About the Author
Jared Hecht is the the CEO of Fundera, an online marketplace for small business loans. Prior to Fundera, Jared co-founded GroupMe, a group messaging service that was acquired by Skype in August 2011, and subsequently acquired by Microsoft in October 2011. Jared currently serve on the Advisory Board of the Columbia University Entrepreneurship Organization and is an investor and advisor to startups such as Codecademy, SmartThings and TransferWise.