Businesses need start-up capital and essentially there are only three ways for them to get it. The first is for their founders to put up their own cash, the second is for them to seek investment and the third is to get a business loan. As businesses grow, they may then need funds to expand and much the same options apply. These funding sources can be accessed individually or used together. Here are some points to consider when deciding whether or not a business loan is the right choice for your business at any given point in time.
The payoff for your business must be greater than the cost of servicing the loan
This may seem like stating the obvious, actually it is, but it’s the fundamental premise of any loan, which means that you need to do your sums very carefully before you approach any lenders. An example of this would be using a loan to expand your physical space (or to expand into physical space if you’ve previously only worked online). You would need to work out how much revenue you could realistically expect to receive from this expansion and also ideally how it would vary throughout the year (which might influence the timing of your expansion) and then look at what you would incur in the way of extra costs (for example, if your revenue goes up, then your taxes may go up too). This will allow you to calculate how much you could afford in terms of interest charges and still make an acceptable profit. The same basic idea applies to loans for equipment or for hiring new talent, both of which are other, fairly common, reasons for taking out business loans. Remember that if the sums don’t add up now, you may still be able to find a compromise solution until you are in a position to make the change you want, for example, instead of moving into bigger premises, you could look at finding “pop up” spaces.
Businesses need credit records too
Young businesses are like young adults, lenders have no past history to use to judge how well they will manage credit. This means that it may actually be worth taking out the smallest business loan you can get purely to start building up a track record of financial responsibility. This may actually seem counter-intuitive since many young companies need to watch their finances very carefully and may be reluctant to take on debt, with its associated costs, when they could manage a purchase out of their existing funds. The point, however, is that the interest payments on a business loan can basically play the role of an insurance policy, helping to protect you against being turned down for a loan when you could really use it. Of course, this only works if you can actually manage the loan responsibly, otherwise it could actually damage your credit rating and hence your ability to get credit in future.
Business loans allow you to keep control of your business
The basic difference between an investor and a creditor is that the former has the right to a say in the running of your businesses (proportional to their investment), whereas the latter simply wants their money back with interest. Bringing investors on board can be very useful if they bring helpful expertise with them and thereby contribute to the company’s development, but friction can arise if the founders and the investors have different views about the direction the company should take. It’s also worth noting that the degree of control an investor is likely to demand will be in proportion to their view of how much the company is worth, which may be very different to the opinion of its founders. Creditors, by contrast, care about the company’s financial standing, i.e. its ability to pay back the loan rather than its overall value.