Cash flow issues, buying new equipment, expansion, more inventory for the busy season, or reinforcement of manpower, are just some of the reasons why business owners consider getting a business loan.
But, it shouldn’t be done hastily. You need to assess the current situation of your business and consider important factors that come with it. Whether you just want to keep your business afloat or you aim to grow your company, a business loan is an important tool in an entrepreneur’s toolbox.
When applying, you’ll need different forms of collateral or guarantees to secure the loan. These may business assets, such as equipment and real estate. Getting a business loan is risky. There’s a lot at stake.
That’s why you need to consider your options before taking out a small business loan. Here are six critical things you need to consider first.
1. Is it indispensable for your business?
It’s the first important factor you need to consider—is taking out a business loan necessary?
Only take out a loan when you truly need it. There are possible consequences that could put your business at risk.
When should you take out a loan? A justifiable reason may be to renovate an outdated facility or store or purchase new inventory. Never get a loan for frivolous things like paying for employee party, a team retreat or other unnecessary expenses that won’t benefit your business.
2. How much funding do you need?
Be realistic about the amount you’ll need. Take out enough to accomplish your goal but not too much. If you take out a loan for more than you actually need, it’ll affect your income-to-debt ratio, and interest can be costly. Also, make sure to include loan fees into your calculations when deciding how much you can afford.
In addition, some lenders may not loan you the amount you need. Do your homework first, especially if you have specific lenders in mind.
3. Do you have a good credit score?
Your credit score, both personal and business, is an important metric that every lender or creditor will evaluate.
The higher your credit score, the better chance for your loan to get approved. Your business and personal credit score will influence your likelihood of getting a loan. These two will also determine if your loan needs to be secured with collateral or a guarantee, such as your business or your property.
Personal credit scores over 650 are considered good (likewise, a business credit score of 75 is good). Having a score lower than that could make it difficult for you to find a financial institution that’s willing to lend you money. If you find one, they may charge hefty interest rates.
4. How urgently do you need the money?
If you’re in urgent need of money, getting a traditional bank loan might not be the best option for you. Typically, the process of applying for a loan can take up a week or more.
If you have time and know you’ll need money in the future, start preparing as early as you can—perhaps build up savings or improve your credit score.
5. Are you capable of repaying the loan according to the stated terms?
Be sure you thoroughly understand the terms of the loan. Then evaluate your cash flow. You have to be able to repay the loan on time. Otherwise, you risk damaging your business or personal credit, paying high fees and perhaps losing assets.
If you don’t think you can repay the loan according to the stated terms, don’t take it. Getting a business loan with unfavorable terms will only make your financial situation worse.
6. Do you know what’s written in fine print?
Read the fine print before signing on the dotted line. There are many available loan options out there, so sift through the terms carefully.
Look closely at the payment structure. Are there early payment penalties or origination fees? Is the interest going to be higher than the principal over the life of the loan? Is there a balloon payment at a specific date that you did not anticipate?
These are just some of the many factors that need careful consideration before getting a loan.
