Securing financing is one of the most critical business requirements, whether the company is just starting or choosing to expand. Access to capital can make all the difference in a venture’s success. It can help cover startup costs, purchase inventory and equipment, and invest in growth initiatives like marketing.
With adequate financing, businesses may take advantage of opportunities to reach their full potential. As a result, securing funding is a top priority for entrepreneurs and small business owners.Â
However, not everyone has the chance to overcome financial challenges by themselves, which is why loans exist to help businesses bridge that gap between assets and opportunities. This guide covers the pros and cons of getting a business loan to help you decide.
Types of Business Loans
Before getting into the pros and cons, knowing your options is best. Here are the most common types of business loans.
1. Term loans
Term loans are a lump sum given upfront with typically fixed interest rates and regular payments lasting for a set term, hence the name. Businesses usually take term loans for long-term plans or considerable, one-time investments, like purchasing real estate or equipment.
2. Lines of credit
Lines of credit (LOCs) are like credit cards for businesses, allowing the owner to borrow money up to a limit and only pay interest on the amount borrowed. This loan type can benefit companies that need help paying short-term expenses, like payroll or inventory. While more flexible than term loans, LOCs typically have higher interest rates.
3. Invoice financing
Invoice financing is a short-term loan for businesses that use a payment scheme that lets customers pay later. A company can receive a percentage of its awaited payment immediately using this loan type, giving instant access to funds for spending elsewhere.
Pros and Cons of Obtaining a Business Loan
Getting a business loan can be a valuable tool for growth and expansion. However, in return for the capital, your business takes on responsibilities and risks you must consider.
Pros:
Here are the benefits you receive from a business loan.
1. Access to capital
A loan can be the funds you need to cover startup or expansion costs, allowing you to take advantage of growth opportunities. A loan can help fuel revenue growth and establish a solid financial foundation for the future once you pay it off.
2. Credit score improvement
Practicing good business loan management and making regular and timely payments improves your credit score and financial reputation. This change can increase your access to financing and allow you to negotiate better interest rates and terms.
3. Potential tax benefits
The interest you pay on business loans is typically tax-deductible, particularly for small businesses. Writing off your interest payments can significantly reduce the tax season’s burden, allowing you to focus money on other expenses or investments.
Cons:
Here are the resulting responsibilities and risks you get with a business loan.
1. High-interest rates and accessory fees
The primary drawback of obtaining a loan is the interest rates and fees associated with borrowing. Interest rates can be high, and lenders may charge additional fees for processing the transaction. These additional costs may significantly increase the overall cost of borrowing and reduce profitability.
2. May require collateral
Many lenders require collateral to secure a loan, which can put assets, like property or equipment, at risk if you fail to repay the loan. The loss of collateral can devastate small businesses and, in the worst case, cause the entire venture to fail.
3. Chance to damage the credit score
Besides collateral, failing to make timely repayments can negatively impact your credit score and financial standing. Being known as a borrower who struggles to repay can close off future financing options or make it harder to get favorable rates and terms.
Factors Lenders Consider Before Giving a Business Loan
How do lenders decide to approve a loan? While loaning institutions will have different requirements and measurements, there are a few expectations most organizations will expect.
1. Credit score
Your credit score is likely the first thing a lender will check. Your credit score is a number to denote how likely or unlikely you are to fail your repayment. Your score builds up over time and improves if you show that you can handle loan repayment and don’t overly indebt yourself.
2. Financial history
Lenders will also check your financial history, including your business’s revenue, expenses, and cash flow. It’s essential to have accurate and above-board financial records to support your application.
3. Business plan
Most lenders expect you to provide a business plan and loan application. This document should include financial projections, marketing strategies, and a repayment plan.
How to Improve Chances of Getting a Business Loan
If you choose to apply for a business loan, there are a few tips you can follow to make yourself a more attractive applicant.
1. Find the right lender
Your choice of lender can significantly impact your chances of getting an approved loan. Look for institutions specializing in your industry or have experience working with small businesses. You’re much more likely to have an easier time pitching your loan if the organization understands your field and accepts the risks of partnering with startups.
2. Improve credit score
Changing your credit score is a lengthy process, so starting as early as possible is best. As much as possible, pay your bills on time, reduce your credit card balances, and dispute any errors on your credit report.
If you’re part of a system that measures business credit scores, your credit institution may have other determining factors. For example, they may look into your ability to handle a business loan or history with other lending institutions. Find out what they’re measuring to see if you can do anything more.
3. Prepare the necessary documents
Nearly all lenders will expect the abovementioned requirements, so you should prepare them beforehand. Your financial statements should be complete, and your business plan should be grounded in statistics and realistic projections. The confidence you can get from having all the necessary information is a big plus for lending bodies.
Deciding to Take the Leap
Aspiring business owners and entrepreneurs must take many risks to pursue the dream of owning a successful business. While business loans can be intimidating, reaching for growth opportunities often requires a leap of faith to grasp. This doesn’t mean you should do so with blind faith.
Conduct thorough research into the various loan types and make plans and backups before you decide to take that leap.
