September 2, 2014

The 4 Dangers of Borrowing Money the Wrong Way

We all know that small business lending is down. Still, despite the lending challenges facing small business owners, there are loans being approved and, although it’s never easy nowadays, qualified small business owners are getting approved for many different forms of financing to start, build and grow their businesses.

money bomb

Here’s the question: Are you getting the right loan and borrowing the right way so you do all you can to ensure that you can get the next loan you’ll need for the continued growth of your business?

Some entrepreneurs think that the only goal of borrowing is to get approved or just to have some form of financing they can use. But it’s bigger than that. It’s actually common for businesses to grow and then to need additional capital to propel themselves to the next level. It’s also common for things like debt and credit mistakes to stop them from qualifying for that additional capital.

Here are the four biggest dangers of borrowing money the wrong way when building a business:

1. Allowing Lenders to Take Too Much Collateral With a Loan

This one can be a bit difficult if you’re not familiar with choosing the right bank to work with. Here are some questions to ask yourself:

  • Can you borrow the money you need without pledging any collateral to the bank? Some banks require collateral on all loans;  other banks will extend certain types of loans or lines of credit without any collateral requirements.
  • What is a reasonable collateral request based on the loan you’re requesting? If you’re looking for millions of dollars for a large expansion, you’re not going to get it without collateral. However, if you only need $50,000 or $100,000 for working capital or financing some receivables, you’re an established business and you’ve got good personal credit, then you may be able to get that financing without needing collateral.

You will need to work with a good person at the right bank, but you get the idea.

2. Not Being Committed to Maintaining (or Improving) Your Personal Credit

Although bank financing is challenging to get, it’s always going to be the cheapest form of funding your business. There are “alternative” financing options galore but it should always be your goal to get your business to be “bankable.” In other words, you want to be able to obtain your loans and lines of credit from a bank.

As a small business owner, your personal credit is normally one of the key ingredients in the underwriting process to see if your loan request will be approved. If you have excellent credit, maintain it. Don’t let yourself get “too busy” to pay your bills on time. Don’t use your personal credit cards for  business expenses – this is possibly the biggest credit mistake made by small business owners. If your credit needs improvement, then be proactive about improving it. Your business will thank you.

3. Not Knowing the Impact of Your Loan on Your Budget and Cash Flow

We would probably all agree that excessive debt is never a good thing for any business. But what impact does the loan have on your budget? There are two important factors here:

  • Use the funding you obtain for RGA (revenue-generating activities). If you grow the business with your loan or line of credit, then you’ll probably be able to justify the impact the loan has on your budget and cash-flow.
  • Keep in mind that cash flow is usually more important than interest rates. In other words, if you can extend a loan from a three-year repayment period to four or five years in exchange for a little higher interest rate, consider what lower payments mean to your budget and cash flow. If that saves you $150 a month in the form of a lower payment then it may be your best bet. If you end up growing faster than you project and your cash flow is excellent, you can pay that loan off at an accelerated pace. However, if your growth is slower than you expect or you have tight cash flow, you’ll be glad you extended the terms.

4. Choosing the Wrong Loan for Your Purpose

Do you need a loan or a line of credit? Based on your credit, business, industry, collateral, revenue, profit, etc., do you know what your borrowing options are? If you understand what your options are, you can choose the loan solution that’s best for you.

I recently worked with a printing company that requested a factoring facility but they actually qualified for an unsecured business line of credit from a bank. That meant a lower cost, no UCC lien against the business, and no notification to their creditors about selling their receivables to a third party. Although they qualified for a lending solution that was “better” than they thought, it’s probably much more common for small business owners to think they can get bank financing when they really are not “bankable.”

My conclusion brings me to my two favorite words in business: knowledge and execution. Know your borrowing options (most small business owners don’t) and then execute. Period. Get your funding, use it for RGA, and keep living the dream!

12 Comments ▼
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Tom Gazaway


Tom Gazaway Tom Gazaway is President of Hawkeye Management, a firm that specializes in providing unsecured working capital for small business owners. Through their pre-qualification process and detailed analytics, they match small business owners with lenders who will issue business credit without collateral. Tom also blogs at Business Finance Lounge.

12 Reactions

  1. Thanks for the post, Tom.

    I’m curious; how realistic is it to get a small business loan in this climate, without pledging any collateral?

    Thank you!

    The Franchise King®

  2. I think the most important question for the SMB to ask before getting a loan is “Can I do what I want to do without this loan?” If the answer is no, keep moving down this road. However, I think that often times the answer is yes, but it will take you longer. Then ask how much longer and weigh that against the costs of the loan.

  3. Joel, thanks for reading and for your question. I would agree with anyone who says it’s difficult but it’s also our main business model so we’re constantly working on lending solutions that don’t require collateral for small biz owners. There’s not many unsecured “loan” products with the exception of some smaller personal loans from banks, credit unions, and P2P lenders. There are more “line of credit” options if you know the right qualifications, the right lenders, and how to get them done. It’s a challenge but you can also include credit cards in the equation and you’ve got a variety of different solutions to consider. From my experience they all require pretty good personal credit from the business owner and they all have a different set of benefits. When you get familiar with the best options you’re normally looking at unsecured credit lines that are between $5k – $100k with anything over $100k being possible but very difficult. Thanks again for your question.

  4. This is a Great Article and well crafted… It specifically focuses on the idea of the Business Owner being knowledgeable about not only their business but also their options. The Business Credit market is something you, as a Business Owner, will want to know how to navigate. The idea of being “bankable” is another extremely important point, where you must have all your i’s dotted and t’s crossed in order to get the funding you want…

    Most times it is NOT a bank loan… but a Line of Credit, that will get you further than anything…

    Also the idea of having access to capital before the implied situations that are covered in this article come up, is the best form of active cashflow management I can think of…

    Why wait until you want to grow to get the money to grow?
    Why not go and get the credit needed for your growth spurt before that growth spurt is upon you… this puts you in a more advantageous position when opportunity or entrepreneurial exuberance strikes…

    Proactive measures vs. Reactive moves

  5. Matt, great comments so thanks for your input. I esp. love your suggestion to get the funding before you need it…when it’s a line of credit this is one of the golden rules of bank borrowing. For Small Biz Owners who feel like they can’t keep up in the rapidly evolving and changing credit markets it’s also wise to think of a credit & lending expert along with their lawyer and accountant as part of their core advisory team. Thanks again Chris for your comments and insight.

  6. Great article. One the most important pieces of information in this is in #3 – to use the loan for revenue generating activities. Some businesses use the loan to hire non-revenue generating employees which will only work for a short time unless they are there to free up time for you to produce more revenue.

  7. Thanks Lionel. I’m glad you like the idea of RGA. I agree with you that the funding isn’t always used properly or in the best way by business owners. We’ve got some soft formulas that we suggest to clients for how they utilize the funding they obtain but it’s obviously always going to be up to the business owner to make good decisions. Thanks for your comments.

  8. Great Article, I have been thinking of starting a small home based business and was figuring my startup capital would come from my savings and my personal credit cards. I had no idea nor ever heard of the ideas in this article, how would you suggest to be the best way to get started ? I figure I would need about 25-50k the more the faster the sartup goes. Will be following your blog.

  9. Hey Paul, thanks for your comments. There’s a lot of content on our blog if you want to reference it that may help. We’ve also got a whitepaper on the 6 goals of unsecured business credit so feel free to drop me an email at tom@hawkeyemgmt.net if you want a copy of that. It may help. You can always contact us and we’ll let you know if we can be a resource for you as well. Thanks again for your comments and best of luck with your new venture.

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