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Should you borrow a business loan to start your business?
Many successful businesses started out with a loan, but this doesn’t mean that going into debt is the best way to finance your business.
Should you borrow a business loan to start your business?
According to the Bureau of Labor Statistics, about 20 per cent of small businesses fail within their first year and only half make it to their fifth year. Two of the biggest reasons why small businesses fail stem from money: insufficient capital and unchecked cash flow problems.
Some business owners and entrepreneurs apply for business loans in order to meet the costs of starting their business. But with the multiple options available beyond the bank, a business loan may not always be the best option.
Even if you ask experienced business owners, you may be met with conflicting opinions: some may caution you against going into debt, while others may support the idea.
Consider the pros and cons below before deciding on your business financing:
Cons
A business loan means starting your business with a debt
Taking out a loan means your business is already losing money before it even starts earning.
Just because you’ve already opened your business to the public doesn’t mean it will immediately take off. But even with a low income, you will still be expected to make loan repayments.
If you don’t have enough savings or income to meet your loan obligations, you may end up losing your business.
You may have to provide a collateral or seek a guarantor
Most lenders would require a collateral or guarantor before approving your loan application.
Many small business owners resort to using their personal property or convincing a family member or friend to guarantee the loan. However, these come with its own set of problems.
Remember that if your business fails or you fail to make good on your loan repayments, the lender has the right to take your property. You will also place your guarantor in a financial bind since they must pay off the loan in your stead.
The interest rates you receive may be high
If your credit score isn’t good enough for the lender, considering the type and amount of loan you’re applying for, you may receive unfavourable rates.
A high interest rate could make your loan repayments higher and the total cost of your loan more expensive.
Pros
You’re borrowing to build up your credit score
Banks lend more willingly when you don’t really need the money.
If you already have enough capital to start up your business but you plan to expand in the future, you may take out a loan to start building your business credit. This should allow you to establish a good relationship with your lender and qualify for a bigger loan in the future.
You need expensive but necessary equipment
There are specific types of loans that you may apply for if you simply need equipment.
These types of financing allow you to purchase the equipment or machinery that is necessary to run your business and use only what was purchased as security for the loan.
Your business profits can outweigh the debt
If the potential returns of your business far outweigh the risks and you can pay off your debt with much of your profits still intact, you may consider financing through debt.
It’s best to ask yourself if you should really take out a loan to start your business before even approaching a lender.
If you decide that taking out a loan is the right move for your business, make sure to calculate the amount of loan you need and borrow only the appropriate amount.
Too much or too little money can affect your future cash flow: Too much loan means larger payments, while too little may result in insufficient funding for the loan purpose.
We recommend reading nestegg’s “How to get banks to say yes to your business loan” for more tips on securing your loan.
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