Common missteps small businesses take when obtaining financing
Borrowing money for the first time is a big decision and much thought into the structure of the debt as well as the amount that will be borrowed should be undertaken. This article will highlight some of the more common pitfalls that businesses experience when borrowing in order to help those companies from avoiding those mistakes.
1) Have a predetermined plan: Before borrowing a small business should understand why they are borrowing, how they will deploy those funds, and how they will be able to repay the debt. While things may not go exactly to plan, having a structure in place will help the business understand why they are looking to accomplish with the loan so that they can structure their debt accordingly.
2) Don’t borrow more than needed: While it can be difficult to gain access to a loan, once that amount is granted a small business will often borrow as much as is allowed by the bank which can become burdensome for the company going further. Instead assess what amount is actually needed and structure a loan that provides sufficient borrowing capacity but not to the extent where funds go unused. If your small business is in need of seasonal financing to find business during peak times you may want to consider a revolving line of credit that can provide the flexibility that you are looking for.
3) understanding the types of financing available: There are many different forms of financing that are available to small businesses including term loans, convertible debt vehicles, revolving loans, mortgages or equipment loans, and hybrids of these. Each have their own advantages and disadvantages and understanding the benefits of each can go a long way towards helping you to select the form of debt that fits your needs. Start by educating yourself on the various forms of debt and understanding the characteristics of each.
4) Make sure you can meet the debt covenants: Most loans require that the borrow maintains some basic financial stability that are tested regularly with bank covenants. If you trip these covenants the bank can call your debt and require immediate payment. While in practice most banks will forgive tripped covenants and extend terms so that you are able to eventually pay the loan back, it is better for all involved if you are able to meet your loan covenants. Start by making sure you understand how the covenant is calculated and test your current financials to see if you would violate the covenants now, or once the debt amounts are borrowed. Then perform stress tests before signing the loan documents to make sure you would still comply with minor decreases in your earnings.
It is a good idea for the owners and management of a small business to explore these items before entering into any financing agreement for their company.