Smart Borrowing: When and How to Use Business Loans for Small Business Owners

You may have heard (or read) this a million times, but I’ll say it again (and again and again) – CASH IS QUEEN. If you are still not focusing on your cash right now, let CB Insights survey bring it home for you.  In their recent survey, they found that one of the major reasons for businesses failing is running out of cash and their inability to secure funding . If this ain’t scary at all andyou have enough cash, good! But if you are tight with capital or you’re a business owner with aspirations to grow and scale, but currently have no cash to fund that growth, stay with me because this article is for you!

As an existing small business owner or aspiring entrepreneur, you’re likely no stranger to the idea of business loans. They can be powerful tools for your business – either they can:

(1) provide you with the capital necessary to move your business toward success
or
(2) cause trouble if not used properly that may cost you a fortune!

Navigating the world of business loans requires finesse and careful consideration. In this article, we’ll dive into the ins and outs of using business loans wisely, exploring the advantages, and disadvantages, and when’s the right time to consider them.

But first, let’s just ground ourselves on “WHAT IS A BUSINESS LOAN?”

A business loan is a debt financing tool a where a lender provides funds to you, the small business owner, for a specified period (months or years) with predetermined terms on when and how they will get the money paid back (e.g., interest, mode of payment, other agreements).

 

Advantages of Business Loans

1. Tax-Deductible Interest

One of the standout advantages of utilizing business loans is that the interest you pay on them is often tax-deductible. This can reduce your overall tax burden, freeing up more funds for your business’s growth and development.

2. Finality of Repayment

Once you’ve successfully repaid the debt, it’s behind you. Unlike other forms of financing that might involve ongoing revenue sharing or ownership stakes, a business loan doesn’t continue to impact your business’s financial structure after it’s fully paid off.

3. Does Not Provide an Ownership Take

Business loans don’t require you to give away ownership stakes in your company. This means that even as you receive the necessary funds, you retain full control over your business operations and future decisions.

4. Predictable Interest Rates

Fixed interest rates on business loans provide stability in your financial planning. This predictability makes it easier to manage your cash flow and allocate resources effectively. Note, not all loans have fixed interest rates, some have variable interest rates where interest payments can change, so here we’re just referencing fixed interest rates that have the advantage of predictable interest rates.

5. Potential for Low-Interest Debt

For finance savvy CEO’s, there’s an opportunity to secure debt with incredibly low or even 0% interest rates. This can be a game-changer in terms of minimizing the cost of borrowing.

6. Building Business Credit

Consistently repaying business loans on time can help you establish a strong credit history for your business. This can unlock better terms for future borrowing and open doors to more substantial funding.

 

Disadvantages of Business Loans

1. Repayment Obligation

No matter how your business is faring, loan repayment is a commitment that must be honored. Even if your business faces setbacks, the loan payment remains due.

2. Collateral Requirements

Some loans might necessitate collateral, which can be a valuable asset you need to pledge to secure the loan. This introduces an element of risk should you be unable to meet your repayment obligations.

3. Fixed Payment Schedule

Loan repayments follow a fixed schedule, which means they’re not contingent on your business’s monthly performance. This can be challenging if your business experiences seasonal fluctuations or unexpected downturns.

4. Impact on Credit Score

Missed loan payments can have adverse effects on your business’s credit score. This can make future borrowing more challenging and impact your overall financial standing.

5. Perception to Investors

Equity investors might view your business differently if you already have a significant amount of debt. High levels of debt can signal heightened risk, potentially deterring potential investors. (To know how much debt you should have as a small business, learn more here.)

6. Interest Expense

Remember, borrowing isn’t free. You’ll be paying back not just the principal amount but also the accrued interest, which adds to the overall cost of the loan.

 

When Does It Make Sense to Consider Business Loans

A Good Idea:

✔️ If having the capital is essential for growing your business or launching your business.

If you need capital to drive significant growth or launch a new business endeavor that already has a proven market fit, a loan can provide the necessary funds.

✔️ If the capital will enable you to deliver on a product or service that already has a customer commitment to purchase.

If you have a signed commitment from a customer to purchase, but need the capital to secure the resources to deliver the product or service and as such receive the associated payment from the customer.

✔️ If it allows you to make more money.

When the borrowed capital can be invested to generate more revenue that exceeds the cost of the debt, allowing you to increase your business’s profitability.

✔️ If the money you are borrowing will allow you to grow it or if it allows you to develop your business in some way that makes it more valuable.

✔️ If it is 0% or very low interest.

Consider loans with minimal interest rates or promotional periods of 0% interest to maximize benefits.

✔️ If it allows you to build your credit history.

Utilize loans as a tool to build a positive credit history for your business.

 

A Bad Idea:

❌ If you are borrowing money to use it on something with a return that is very uncertain or very risky.

Borrowing for ventures with highly uncertain or risky returns might lead to financial strain.

❌ If the interest rates are high and high fees are associated with the debt.

❌ If the consequences of non-repayment are too high (i.e. your only personal assets).

If non-repayment could result in the loss of critical personal assets, it’s wise to reconsider.

 

Using Business Loans Wisely

To make the most of business loans, follow these steps:

1. Start with a Clear Financial Plan

According to a survey, the top 3 reasons why business owners apply for a business loan are: business expansion (42.4%), equipment purchase (29.4%), and marketing & advertising (28.6%)

• Identify exactly why you need the funds and how they will contribute to your business’s success. (Example: technology investment)
• Determine the specific amount you need and the timing of when those funds will be required. (Example: $15,000 by December 2023)

Notes: Borrow only the amount necessary for your planned business activities. Avoid the temptation to over-borrow, as it could burden your business unnecessarily.

2. Create a Detailed Repayment Strategy

Develop a comprehensive plan for repaying the loan, factoring in interest and any fees.
Ensure your repayment schedule aligns with your business’s cash flow.

 

CONCLUSION

In conclusion, business loans can be powerful tools for you, small business owners, providing access to crucial capital for growth and development. By understanding the advantages, disadvantages, and strategic timing of borrowing, you can make informed decisions that positively impact your business’s trajectory.

Remember, every business’s situation is unique, so assess your needs, financial capacity, and growth prospects before embarking on a borrowing journey. When executed wisely, business loans can be key drivers of success in the entrepreneurial landscape.

Remember to consult with a financial advisor before making any major financial decisions. Your business’s future deserves the best possible guidance.