Is Taking out a Business Loan a Good Idea When You Start?
There’s always some hesitation taking out a business loan. Is the time right? What if you can’t pay it back?
In the following article, we’re going to look at the pros and cons of taking that step. But first, let’s examine some pre-application questions that you need to be asking yourself.
Questions You Should Ask Before Taking Out a Business Loan
Before getting into the decision-making process, you’ll need to lay some groundwork. Namely, what type of business do you plan on going into and what resources do you have in place? Once you’ve answered those questions, it’s time to ask several more.
What Is the Overhead?
Most businesses come with a certain amount of overhead. It doesn’t matter if you’re selling a product or a service. You need tools and resources that provide those products and services.
You’ll also likely need people to help sustain the business as well as a location for doing it. There also may be some permitting and accounting requirements.
Whatever your overhead is, figure it out. Until you have a clear number or at least a very good estimate, you’re not ready to take out a loan.
What Are Industry Conditions?
One of the most common questions we hear: is it hard to get a business loan? The answer to that will depend, in part, on the conditions of the industry you’re planning to enter.
Pick something in-demand, and you’ll find the lending environment to be a more welcoming one. Go with a higher risk factor, and you’d better have some serious street cred.
What Is the Cash Flow Potential?
Some entrepreneurs seek a loan to buy a business instead of start one. That can be a wise maneuver for franchises or long-established brick-and-mortars as these generally come with reams of data showing the cash flow you can expect.
If you’re starting a business from scratch, cash flow potential can be harder to prove. You’ll need a written plan that answers all the hard questions lenders or investors are likely to ask. (Mainly, how will I get my money back?)
What Forms of Collateral Will Be Involved?
Collateral is an asset or group of assets that show a lender you’re good for the money. If you’re starting a second or third or fourth business, then the performance of the others could be your collateral.
You also might leverage your home equity and other paid-for assets to access the loan or line of credit needed to fund your business. Make sure it’s a wise investment before trying to leverage those assets.
Is Credit Where It Needs to Be?
The last thing you’ll need to do is check in on your credit. It’s easier than ever to access recent credit scores. See if you have a credit card that offers this feature and takes advantage of it.
A strong credit score gives you enough peace of mind to ask. A poor one can prepare you for the obvious disappointment of not qualifying for a business loan. It can also be just the motivation you need to get it together.
Now that we’ve covered the questions you need to ask before taking out a business loan, let’s look at some things to know. These include the pros and cons of sending in that application.
When It Is a Good Idea to Borrow?
Yes, contrary to what some might say about borrowing money — and we’ll get into their reasons in a moment — there are times when it makes sense to apply. Most of it depends on the type of business you start and the decision to scale. So before you take that step, make sure of the following.
1. Revenue Is There
When you buy or start a McDonalds in a mid-sized area, you automatically have a background that you can point to for the lender. That background can give a clear depiction of what other McDonald’s in similarly-sized locations are doing.
If the revenue to manage the debt service is dependable, then you might want to consider taking out a business loan. However, like logging into Facebook, you’ll want two-factor authentication before proceeding.
2. Scaleability Is On-Point
Some businesses must scale if they don’t want to get left behind by the competition. If it would hurt your business not to scale, then you’ll need the working capital to do it. See where you’re at in relation to your closest competition and go from there.
3. You Have the Right Level of Maturity
Have you ever had difficulty living on a budget, buying things you don’t need on a weekly basis, and missing payments? None of that makes you a bad person, but it does make you suspect as a lender. Don’t borrow until you’re mentally ready, in other words.
When It Is Not
Some loans are horrible ideas. It depends on the timing, the idea, and the person. You can usually tell you’re about to step in it when the following situations are true.
1. The Concept Is Unproven
So you want to start a business. You want it to be the “first of its kind, nothing else like it in the world.” Big deal.
Lots of people would like to start a business. The idea they have is the newest, most brilliant, epic, etc. Regardless of the reason, not everyone should.
Even if you qualify, you may end up borrowing just enough money to create trouble. More on that in the next section.
2. It Adds More Expenses Than the Business Is Ready For
Businesses that are unproven run into unforeseen circumstances once they get things off the ground. If this happens on the expense side, then you could end up burning through your cash quickly and stuck with expenses that your revenue sources cannot cover.
3. You Already Are in Financial Turmoil
Financial turmoil often is defined as bad credit. While that’s certainly a “tell” that not everything is going as it should, it’s not the only cause for concern. Some people with excellent credit struggle to make wise financial decisions.
They simply keep their heads above water by earning a good paycheck that’s mostly spoken-for by the end of the week.
Business Loans Should Never Be an Instinct
If you take nothing else from this, know taking out a business loan isn’t something that should be done flippantly. You should weigh every benefit, disadvantage, and concern against your specific situation.
Good luck. And while you’re here, check out more of our advice on business management and funding tips.