Thinking about taking out your first small business loan? Or did you just pay off your last one, and are debating taking out another? Let’s dive into the details and help you make a decision.
Benefits of Small Business Loans
The most common reason for a small business loan is to cover cash flow issues. A small business loan saves you from having to let employees go or close your business altogether when you go through tough times. It can also be great for seasonal businesses that need to buy in bulk at the beginning of the season.
Your business has a credit score just like you. While most loan applications will strongly consider the business owner’s personal credit score, the business credit score will come into play as well. The same criteria to improve your personal credit score applies to your business credit score: a history of timely payments, and repayment in full. A small business loan repaid in a timely manner is a great way to boost that business credit score and improve your future credit options.
Most small businesses will need a sizeable amount of capital to really grow, whether that’s acquiring a competitor or adding locations. A small business loan gives you the capital, with repayment terms stretched over years as you hopefully receive a return on the capital investment.
Risks of Small Business Loans
Debt isn’t free. The main risk of getting a small business loan is paying it back if your idea fails, plus interest.
Debt can also be addicting. Getting multiple loans may seem great at first, as you can finally make your dreams come true, but those repayments can hurt cash flow and make tax time difficult. It can also make your balance sheet look bad, making it more difficult to get additional loans if you need them.
Debt can also restrict your freedom by incorporating covenants. Failing to meet those covenants can result in the lender calling the loan.
Small Business Loan vs. Small Business Line of Credit
You may be wondering how lines of credit come into play and how they compare to loans. Lines of credit are established ahead of time, and often have higher interest rates. You have the ability to draw on the money, but it isn’t provided unless you request it. Small business loans are different. The lender approves your application and sends you the funds in full. It is your responsibility to use the money appropriately and repay according to the terms.
Given the higher rates and preestablished amounts, lines of credit are best for short term needs. For example, you have payroll this week but cash is short. Draw on your line of credit to make payroll, and then immediately repay the line of credit next week when that customer finally pays you.
Small business loans are better when the amount you need exceeds your approved line of credit, and when the period of time lasts longer, such as a months-long building renovation or a big equipment purchase that will generate additional income for years to come.
When to Get a Small Business Loan & Line of Credit
Line of Credit
Apply for a line of credit when you don’t need it. You will be approved for more when your company is doing well and your balance sheet looks good.
Beyond the obvious of getting a loan when you need it, analyzing your financial statements can give you a clue as to when you actually need an infusion of capital. Has growth stagnated? Perhaps you need a bigger space to hire more people that can produce more. Equipment breaking down? Upgrade for improved efficiencies and profits.
Plan ahead because it can take time to get approved and receive the funds. There can also be competition for a specific amount of funds, as we all saw with the PPP loans during the pandemic.
Note: Beware of usury! Lenders are not allowed to charge egregious interest rates, but they know when you’re in a tough spot. While a higher interest rate may be justified due to their risk exposure, it must be fair.
Working with Haworth & Company, Ltd.
We’re invested in your success, and advising on your financial position and the pros and cons of taking small business loans is a part of that. We were able to help tons of clients survive the pandemic with EIDL and PPP loans, and we continue to look into the latest developments and resources available for our clients. If you’re debating expansion in MN, struggling to meet payroll, or frustrated by a lack of growth please contact us and see what we can do to help you.