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5 Lessons to Learn about Small Business Loans

November 27, 2013 by Ed Becker

Loans are an essential component of small business success. According to the Small Business Administration (SBA), “Insufficient or delayed financing is the second most common reason for business failure.” This became all too clear during the global recession of 2009 when thousands of small businesses rapidly collapsed after losing access to borrowed funds. Understanding the caveats of small business lending will help your business borrow responsibly and become immune to the next major financial crisis.

Lesson 1: Start on a Shoestring Budget

Sinking too much money into a business during its early stages of growth can be a recipe for disaster. A commonly cited warning is that 50% of businesses fail within the first five years. Although some failures can be attributed to insufficient debt financing, the majority of small business failures are the direct result of inexperience, poor credit arrangements, and an over-investment in fixed assets. Starting on a shoestring budget will keep mangers fiscally disciplined and continually focused on cutting costs. On the contrary, businesses that start with ample debt financing will be tempted to spend frivolously, keep overpaid employees on payroll, and ignore cost saving opportunities.

Lesson 2: Cash Flow is King

Cash Flow

Before even considering a small business loan, it is crucial to have accurate projections of your business’s future cash flow. Debt financing will always increase cash outflow with a monthly payment for principle and interest. A business owner must be able to demonstrate stable capital inflow to cover all existing expenses in addition to the new loan payment. Creditors will closely scrutinize your cash flow statement and liquidity ratios. Hiring a professional accountant to prepare forecasted pro-forma financial statements will provide a valuable asset when pursuing a small business loan.

Lesson 3: Prove your Creditworthiness

Early stage entrepreneurs will be highly dependent on their personal credit rating to secure a small business loan. A startup company will typically lack the cash flow and credit history required for a vanilla loan, thus requiring a personal guarantee to come from individual owners. Prior to applying for a loan, it is important to make an effort to improve the personal credit ratings of all business partners involved in the organization. Keep in mind, this scenario will often include the personal assets of the business owners as collateral.

Lesson 4: Understand the Details of the Lien


In order to secure a loan, your bank will place a lien on business assets and/or personal assets, such as real estate and equipment. Small business owners often overlook this detail because they are more concerned with the interest rate and monthly payment amount. Most significantly, the details of the lien can affect a debtor’s ability to borrow money in the future. If the first loan places a lien on the business’s most valuable assets, it could discourage other banks from loaning additional capital in the future – even if the business has a stellar credit rating.

Lesson: 5: Rejected? Consider SBA Loan Programs

Don’t sweat it – obtaining a small business loan has been a challenging task in recent years. Fortunately, the US Small Business Administration offers a variety of loan programs to help under-qualified borrowers obtain financing. In fact, a variety of loan programs are in place to help business owners with startup costs and working capital requirements. The most popular program is the SBA 7(a) loan, which provides a wide range of small businesses and entrepreneurs with growth capital.

Borrowing is a make-or-break decision for many businesses. It is important to tread lightly when committing to a loan, especially when personal assets are at stake. There are very few shortcuts for getting rid of small business debt, so always carefully consider the risks before signing on the dotted line.

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