Business financing can be a great way to build out your company, get valuable capital and invest in areas that can lead to overall growth. But, of course, it’s only a good idea to take out money when you actually need it — and to avoid common pitfalls that can cost you a lot of money.
Getting business financing can be an arduous, time-consuming process that doesn’t always lead to success. Before you submit that application for business financing, it’s essential that you not only know how you’ll use the funds, but that you also consider how to position yourself and your business for the highest chance of approval.
Not having a plan for how to use your funds
A business plan is a valuable piece of documentation for any business, whether you’re a startup or an established venture. If you’re planning on taking on financing, your business plan should address the question of what you plan to do with your new funds.
Whenever you take out a loan it should be to help you add value to your business or increase your return on investment.
Whenever you take out a loan it should be to help you add value to your business or increase your return on investment. If you can’t explain in your business plan why your financing helps you do either of those two things, you probably don’t need it.
Ignoring your business credit
Most people know that they have a personal credit score that affects whether they can apply for a certain credit card or rent that new apartment. But even fewer owners know what their business credit score is — if they even know they have one.
Your business credit score is not a reflection of your personal score.
Your business credit score is not a reflection of your personal score. It takes into account factors such as the length of time since your oldest business financial account was opened, or whether you’ve had any late payments to vendors recently. A better business credit score can help you secure a loan or line of credit, with more favorable terms and higher limits. A poor score may limit your options.
Rather than apply for funding and hope for the best, review your business credit report (as reported by different bureaus). You may even find that the score has an inaccuracy that you can address and rectify, strengthening your case for a generous loan.
Failing to adjust your credit card use over time
Many business credit cards have an introductory offer of 0% APR for the first year or so. This is an excellent promotion because it essentially turns your business credit card into an interest-free loan.
Failing to adjust your credit card use as you transition to a period where interest piles up can send your company spiraling.
But you should never borrow more on your credit card than you can afford to pay back, and this becomes especially true when your introductory rate ends and your APR jumps up to its normal rate. Failing to adjust your credit card use as you transition to a period where interest piles up can send your company spiraling.
It’s not that you should stop using your credit card — good cards offer buyer protection and other perks like customizable cash back categories. Rather, become even more diligent with it as its terms change.
Timing your loan application poorly
When you apply for a loan, potential lenders will review your cash flow, tax returns, bank statements and other information to determine the health of your business. One thing they’re looking for among these documents is proof that your business has a steady income — consistency of positive cash flow is key to convincing lenders that you will pay them back.
The best time to apply for financing is when you're in the middle of a run of consistency. If you wait for a lull in sales to apply, you might have a greater need for a loan, but lenders will see you as a risk — and either deny your application or come back with unfavorable terms.
Overlooking hidden fees and costs
Most forms of financing have fees that are tucked into the fine print of an offer or aren’t expressly stated in the rate they present you. A few examples include origination fees, contract fees or administration fees. Going over an offer with a lawyer or accountant so you understand exactly how much you’re being charged (and thus how much of your loan you’ll actually get to use) is always recommended.
Go over an offer with a lawyer or accountant so you understand exactly how much you’re being charged.
There may be other costs that you’re not considering. If you need to hire an outside professional to take a look at your contract, those billed hours should be factored into the cost of the loan as well.
Stacking your business loans
If you are new to the world of financing, you might make the mistake of “stacking” your loans — taking out multiple loans to address different business needs. Sometimes, this is fine. Other times, it can cause a domino effect that ruins you financially.
For example, using a loan to pay off another loan is risky, and sometimes it’s not even possible: A Small Business Administration loan, which will typically have generous interest rates and repayment terms, cannot be used to pay off debt. If you’re planning on taking out a loan and using another form of financing to pay it down over time, you may be in for a rude awakening.
Comparing APR and interest rate
APR (Annual Percentage Rate) and interest rate are often used interchangeably—they shouldn’t be.
Your interest rate is the interest percentage you have to pay on the amount of money you’ve agreed to borrow. It’s just one thing to consider when you compare loan options.
Your APR is more holistic look at what it will cost you to take out a loan.
Your APR is more holistic look at what it will cost you to take out a loan. It includes your interest rate as well as your closing fees, origination fees, and other charges. It’s typically half a point to a point higher than your interest rate.
The takeaway here is simple: APR and interest rate don’t measure the same things — therefore, don’t put them side by side when deciding between loan offers.
Not comparing your financing options from different lenders
When business owners first start looking for financing, they usually don’t know about all the possible options available to them.
Most people know about traditional term loans — borrowing a fixed amount of money and paying it back over a fixed amount of time. But what about lines of credit? Credit cards? SBA microloans? Invoice financing, or invoice factoring?
The point is, there are many kinds of financing for businesses, and different lenders may offer you different terms for the same product, depending on what factors they use to review your application. Shopping around is vitally important to ensure you’re getting the best possible deal for your business.
Balancing your business’ budget gets more complicated as you take on additional funding, in whatever form it takes. Take the time to research, plan, and execute carefully throughout the process of obtaining new financing, and you’ll be more financially sound as a result.
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