What are the Pros and Cons of a Small Business Loan
You love what your business is doing today, but you know with a bit more capital you could more quickly unlock the next tier or two of growth. The problem is you just do not have the cash to spend on whatever it might be that will provide that springboard. For some of you that may be investing in a stronger inventory position for season, for others its about the money to enable product line expansion, and in some situations it could be incredibly valuable to enhance your operations capabilities, or even to install technologies that will supercharge your businesses ability to execute. Whatever your reason, small business loans can be a tool to help grow faster. While unlocking growth is something we all want, it is important to understand that even though small business loans provide access to capital and help build credit, they do carry responsibilities which are important to be aware of and to believe you are capable of managing. Below we lay out these pros and cons, in an effort to ensure you are fully informed and can make the right decision regarding financing your business.​​
Pros of Small Business Loans
Access to Capital
Running a small business can be cash intensive. It takes money to operate and more importantly it takes money to grow fast. A small business loans can provide funds that enable you to invest in new technologies, to keep staff on full time, or to expand your product range for next season, to allow you to more quickly create growth in your business.
Build Business Credit
In addition to providing capital to grow your business, a small business loan can also help you to establish or improver your credit rating. By consistently paying down your loan you provide a history of trust that drives credit rating agencies to see you as a credit worthy investment, thus improving your ability to secure more or larger financing down the road.
Flexible Uses
Typically, the business has the flexibility to define how the capital is used within the business. You may find the money valuable to drive marketing campaigns, or for hiring staff. Depending on your particular business that money may be best used to increase your inventory, or open a new market. Regardless the use, the decision on how the money is used lies with you.
Potential Tax Deductions
In certain instances, the interest payments on your loan are also tax-deductible. As you consider a small business loan it is important to understand the type of loan and tax treatment of interest payments, as well as to ensure you model the near term and long term financial impacts of the loan on your full P&L. This process will ensure your business can both growth from the capital infusion AND can sustain.
Long-Term Financing
In analyzing which of the many types of small business loans is appropriate for your business, you will want to make sure to consider payment terms. One additional upside to some financing options is the ability to have an increased payback period. Again, it is important that the full impact of the loan over time is built into your business so as to ensure the value created by acquiring more immediate financing is not offset by future challenges due to size of interest payments or length of payment period.
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Cons of Small Business Loans
Debt Obligation
While the money you receive up front for a small business loan can feel like you won the lottery, it all needs to be paid back, with interest. It cannot be stressed enough, the importance of understanding your payments structure and how that commitment impacts your weekly cash flow year. This can be especially challenging if you have a seasonal business or periods of real lean revenues married to high expenses in the business.
Interest Rates
The interest rate will be driven by a number of factors. Historically the considerations were around the particular lender and the credit score of your business, or yourself. In today's climate you also need to consider the impacts of the current macro economic climate and how high interest rates in general will play out over time. As we have seen some easing from the Fed, it is reasonable to believe more may be on the way. You may want to weigh if now is the right time for a loan or if you will be better positioned long term by waiting for deeper cuts and a less impactful interest rate on your repayment plan.
Collateral Requirements
Often, the lender will require you additionally put collateral up against the loan. Collateral can come in the form of personal collateral, like your home, or business assets, like your inventory. This collateral then becomes at risk if you become challenged to repay the loan according to the schedule. This is a significant risk, both to you personally and your business and as such these types of agreements should be entered into carefully and with full consideration.
Time-Consuming Process
Small business loans are rarely the choice for in the moment or an emergency cash injection. The process for submission and approval is lengthy, especially with SBA Loans. The lender will be looking to deeply understand your business, your creditworthiness, and to some extent form their internal opinion on their trust in your growth plans, as these are instrumental to your ability to then pay them back on time.
Impact on Credit Score
One of the largest risks to a small business loan is finding yourself in a position where making payment on time, or making payments at all, is a challenge. The negative impact on your credit score can be very impactful, and the recovery timeline from this drop in score will be take years if the misses are frequent enough. Not only will this challenge your relationship with the lender but it may impact your ability to acquire additional funding down the line.
Acquiring a small business loan can incredibly empowering to your business. It can give you the fuel you need to speed up growth and supercharge your business. What is important to understand, is that the capital you receive comes with commitments and it is vital that you have deeply understood the agreement, the financial requirements, and that you and a trusted advisor have walked the impact of the loan throughout the future trajectory of the business. Only with a thorough analysis of the business plan and the P&L over time can you align the cost of the loan to your ability to afford the repayments. You want to walk away from signing your loan confident you will have the strength of business to pay your loan down as agreed to ensure there are no negative impacts to your business, or yourself, related to an inability to live up to the commitments in the agreement. Small business loans can be an incredible asset to your business, with the right process and diligence, you can acquire one and have confidence your business is now set up for great success with a strong current and future financial health.