October 31, 2014

5 Credit and Financing Mistakes That Will Hurt Your Small Business

So before we dive in, what exactly do I mean by “hurt” your business? Well, these credit and lending mistakes could do any of the following (this is not a complete list, of course):

  • Slow your growth
  • Damage your brand
  • Make the difference between a profit and a loss
  • Cause your business to fail

oops

At the very least you’ll slow your growth or limit yourself from being able to handle the curve balls that are part of business life cycles. It’s also important to state the obvious, which is that we’re only talking about debt capital solutions – borrowing money. We are not going to discuss equity financing mistakes made with VCs, angels, private equity firms and so on.

The credit and lending landscape has not only shrunk from the levels we were seeing in 2005 and 2006 but has also become less consistent and is constantly changing. That means you must be prepared for a variety of factors that can be frustrating, even if you’re working with an expert individual or company in the small business finance arena.

In fact, companies like Commercial Capital Training Group and Compound Profit are capitalizing on the huge need for trusted advisors with expertise in the small business credit and lending space by offering career and training opportunities to individuals looking for a new career opportunity as a small business loan broker. There is such a need that both of these companies are swamped with new trainees.

Bottom line: If you have a proper understanding of your borrowing options, that should create realistic expectations. And if you have those two key components, then you’re halfway there.

These are the five biggest mistakes we’ve seen since the onset of the credit crisis in 2008:

1. Using Personal Credit Cards for Your Business

According to the Meredith Whitney Advisory Group, 82 percent of small business owners use credit cards as a “vital part” of their overall funding strategy. The problem is that most small business owners use their credit cards the wrong way.  They either use personal credit cards or they use business credit cards that actually report to their personal credit report.

Capital One and Discover Card are two of the most popular business credit cards that report their activity to your personal credit report. As a result, they are really no different than using personal credit cards as a funding tool for your business.  When you use personal cards instead of the right business credit card, you hurt your FICO scores, damage your credit file and miss out on the chance to separate your personal and business credit.

We have seen hundreds of small business owners in the last year who needed  extra funding to grow their business and were unable to get it for one reason: because of the impact of using personal credit cards, or the wrong business credit cards, for business.

2. Using Borrowed Funds the Wrong Way

Once you’re approved and you get your funding, as soon as you high-five the nearest person, it’s time to make sure you use the money properly.  It’s tough enough to get funding nowadays, so don’t go spending it without a plan. (We’re  talking about “working capital” funding here. If you get real estate or equipment funding, that’s great, but there’s usually no discretionary funding left on the table for you to spend.)

We talk about Revenue Generating Activities (RGA).  Make sure a good percentage of that loan or line of credit is used to generate additional revenue to grow your business. I like a combination of short-term efforts (a marketing or ad campaign or perhaps a series of trade shows to build exposure and develop key relationships), long-term efforts (building your brand, social media initiatives, building business credit, etc.) and perhaps some “my situation” needs.

An example of “my situation” needs would be to pay down personal credit cards (if you didn’t read this article in time) so you can increase your FICO scores and then obtain additional funding.  Another example would be to give yourself a small salary for a few months while you transition into a more full-time role in the business or to pay yourself back from monies you already spent on the business.

3. Pledging Excessive Collateral With Your First Loan or Line of Credit

Small business lending is constantly changing, and small business owners often think the lender is crazy for saying no, for offering a higher-than-acceptable interest rate, or for failing to live up to their expectations for any other reason. Add all this up and you’ve got a perfect storm.

As difficult as it may be when you’re not working with an experienced small business lender or consultant, try not to give the lender collateral if you don’t need to. And certainly don’t let the lender take an excessive amount of collateral, or you’ll have trouble getting the next loan when that huge, game-changing contract comes your way that will grow your business exponentially.

4. Doing Your Own Research and Getting It Wrong

My guess is that if you were charged with a serious crime you probably would not decide to represent yourself or defend yourself in court. So if the credit and lending landscape is so challenging, difficult and ever-changing then why are you trying to figure it out on your own? We learned a dangerous lesson in the days of easy mortgage money, when websites where you can choose from a long list of lenders and offers became a popular way to find mortgage loans.

The principle behind these sites is that if you talk to enough mortgage companies, you can figure out what the best loan is for your situation. Never mind that you may have no idea about hidden fees, teaser rates and the “bait and switch” tactics used by lenders and brokers, and you’ve never had any training on credit, HUD-1’s, and how to read the 50-plus page mortgage closing package. Despite all that, you’re smart enough to make the right decisions–without professional help–about the largest debt you’ll ever create. I know you’re an exception to the rule but for most “other people” that’s problematic.

Most banks approve less than 10% of the loan applications they get from small business owners. Many of the 10% don’t get as much funding as they need or must give up a lot of precious collateral in order to get their funding. You do the math. Will you be one of the very few who gets everything they need from the bank without pledging an excessive amount of collateral? Do you know where to turn to get the best possible funding after the bank says no? Most small business owners need a good advisor. Even with assistance, getting financing is still a challenge, but at least you’ll be in good hands.

5. Not Treating Your Personal Credit as the Asset it Is (or Not Making it an Asset)

It’s real simple.  You’re a small business owner so you’re going to sign on the dotted line when getting financing.  Yes, to my friends who build business credit, I have Staples cards and gas cards, and a Dell line of credit that did not require a personal guarantee, but those are exceptions and have limitations. We’re talking about the majority of loans and lines of credit that business owners are looking for.

Your personal credit is part of the underwriting criteria (always, for bank lending solutions, and often, for non-bank solutions). Your personal credit is either an asset to your business or a liability.  If it’s an asset, then preserve it and maintain it – and use it the proper way.  If it’s a liability, then do something about it. Find a credit professional who can help you. Please don’t find another mortgage flunkie who now does “credit repair” in addition to three other jobs. Find a professional who can guide you and turn that liability into an asset.

These are some common mistakes we’ve seen small business owners make. We’re all going to make mistakes, but I hope some of my mistakes and some of what I’ve seen will help you make one less bad decision and one more good decision while you take a step in the right direction to start, build or grow your business.

13 Comments ▼

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.

13 Reactions

  1. Thanks for that great information, Tom.

    I’m not really into lots of regulation, but..you wrote that, “Capital One and Discover Card are two of the most popular business credit cards that report their activity to your personal credit report. As a result, they are really no different than using personal credit cards as a funding tool for your business.”

    Those 2 credit card companies should be required to disclose what you just wrote!

    I had no idea, and never would have if you didn’t share that info.

    Thanks!

    The Franchise King®

  2. Hey Joel, thanks for your comments. I sure wish that these companies would disclose these kinds of things but, of course, they don’t. The lack of knowledge in the credit and lending space always amazes me.

    Another frustrating thing is that you cannot trust the answers you receive when you call these large companies and ask these kinds of questions. We’ve repeatedly had them give inaccurate information about credit simply because they’re not really trained to learn how the things they do impact people’s credit. The bad information is pervasive. I hope we’re clearing up some of that and informing people about these important factors related to credit and borrowing.

    Thanks for your comments!

  3. Great information in avoiding the mistakes of credit and loan for business

  4. Thank you for the incite. How does one obtain true business credit cards?

  5. Using personal credit cards, and business credit cards that report to my personal credit score is part of the reason I sold the assets to my business and filing for bankruptcy. I was unable to get additional funding to keep the business going when we needed it most.

  6. Hi Jeffrey thanks for your comment and question. Business credit cards are available at many banks and lending institutions. They are not all created equal and knowing a lot of the details of which ones are best for each situation does require some time in the trenches but just to obtain a business card is just as simple as finding a bank that offers them.

  7. Hi Ekmack,
    Thanks for your comments. It’s unfortunate that things turned out for you that way. I guess we all learn a lot of lessons the hard way. At least you know there’s a better way the next time. Thanks again for sharing.

  8. Great article Tom. I work in the equipment financing industry and focus on small to medium size business. I see this every day with business owners credit. Many people are very uninformed when it comes to financing/leasing and like you said use there personal credit cards for business. That is a horrible mistake. We offer working capital and I can’t tell you how many times I have come across business owners who would rather use up the lines with banks or pay cash for a depreciating asset. Just doesn’t make sense. Thank you for posting this!

  9. Thanks for your comments Matt. It’s always good to get a co-signer on my content lol. It could be a whole different article if we wanted to talk about the best ways to finance equipment. I completely agree that using lines of credit is rarely – almost never – a good way to purchase long-term debt such as equipment.

  10. What are your thoughts on the training group you mentioned, commercial capital training group? My husband is in law enforcement and is bent on attending the training to earn “unlimited money” once he finishes the training. He has no finance background. Is this a good company? I’ve read complaints and I have anxiety about forking over 20k for this training. Thanks for your input.

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