Every entrepreneur’s dream is to expand their business. More importantly to increase their profits to insurmountable levels.
However, to raise enough capital to propel a business to these great levels requires digging deep into the pocket. You need to have finances.
But how to go about this?
You can borrow money and pay back with interest, or you can choose to raise capital through other means like equity financing.
Taking a loan to fund your startup venture is a viable option. In fact, most aspiring entrepreneurs prefer taking this route, but it has its advantages and drawbacks.
This post will look at why you should and shouldn’t consider taking a loan for your business.
Loans are a great way to keep your business afloat. And a lender, relative, friend or company can issue one for you.
What are the key advantages of getting a loan for your startup?
You still retain ownership of the company
Perhaps the most beneficial aspect of taking a loan is your retaining you never have to give up your business.
No matter how bad things get financially, and you fail to repay the loan on time, you will still remain the sole owner of the company. No lender will seize it from you.
That means normal business operations are not affected. Business runs smoothly while you make loan repayments.
Your management is able to run every day’s company activities as usual including choosing board members and making business decisions on behalf of your business.
This is the benefit of debt financing. Lenders cannot seize your business. You still get to retain its ownership while servicing the loan.
As a borrower, you are obligated to repay the loan amount to your lender including the interest rate and principal amount.
Deductions on income tax of your business
Each time you repay a loans interest rate, your business is eligible to income tax deductions.
The IRS (Internal Revenue Service) considers the paying of interest rates as a business expense in itself. In other words, the IRS takes this move akin to remitting your taxes.
Having income tax deductions means you’ve saved money for the daily running of your business.
This helps your business and profits grow. This even helps you raise capital to boost your business.
Reduced interest rates and greater flexibility
Another benefit is reduced interest rates on loans. Depending on terms of the loan and how long you take to repay the loan, a lender can reduce interest rates.
For instance, if you repay your loan early your pay low-interest rates. Before taking a business loan do your due diligence.
Analyze how much interest banks will deduct. Determine the annual percentage rate (APR) you will incur, and the rates you stand to repay.
If a lender’s APR is more than what traditional lenders deduct from your loan, go for a business of loan from a bank by all means.
Banks offer reduced interest rates. That’s a key benefit of getting a same day cash loan from a traditional lender. You enjoy low-interest rates and greater loan flexibility.
What are the drawbacks of taking a business loan?
Getting a bank loan comes with its fair share of disadvantages, and that is expected.
One of them is, you have to repay both interest rate of the loan, and the principal amount borrowed. The same, however, cannot be said of other business funding options.
If your business is cash-strapped and/or in the gutters financially, loan repayment costs can pose a huge problem to businesses cash reserves and cash-flow, too.
Your company also gets slapped with heavy penalties it fails to make loan repayments on time.
Before a lender finances your business, ensure your business is doing financially well or has a steady flow of cash.
This guarantees early repayment. This will help your business from sinking into more debts.
Impact on business credit rating
Another drawback is the impact bank funding has on the credit score of your business. It lowers it.
Much like your credit score, companies have credit score ratings, too. This rating is affected when your business fails to repay a loan on time.
If your credit rating is negatively affected it means your business is affected financially.
With low credit scores, it will be difficult for your startup to get financing from other lenders. This will bleed your cash-flow, cash reserve, and future sales.
If you took a loan for your business, repay the loan on time. It is risky for a business to delay repaying a debt.
This move will have a great impact on the business’s credit rating.
Collateral and cash in hand
Before a lender can offer your business a loan, you need to provide collateral. This guarantees the lender you will repay the loan, but if you don’t they seize your collateral.
This is the downside of this funding option. You must meet a lender’s requirements before they can bankroll your business.
Besides providing security when applying for a loan, you need to have enough cash in hand to qualify.
Collateral can come in the form of property, title deed, cars, and other related assets.
When you fail to make repayments on time, you put assets and properties (used as collateral) at risk.
Because the lender is likely to seize the said assets used as collateral for the loan. This will put the business at risk.
Which are the best alternatives to business loans?
1. Equity financing
Equity financing calls for channeling money into your company or selling shares to prospective investors.
Selling a slice of your business to an investor in return of financial assistance is one way to guarantee the smooth running of your business.
This funding option ensures business sails through without a hitch.
2. Combining both equity and debt financing
This combination is referred to as hybrid financing. Hybrid because you seek to tap the best of both worlds.
It’s one of the best ways to fund a startup venture or raise startup capital to run a business.
However, this alternative makes it difficult to determine what the ideal combination between the two is.
There are costs incurred when you choose to combine these two funding methods. Ensure you understand interest rates you stand to pay, principal amount to pay back, etc.
You have to consider what brings value to your business in regards to securing a business loan or equity financing.
Does giving up a stake of your business to get funding a prudent move? Or, do you prefer to get a business loan and pay high APRs? Weigh out options before you go down this route.
You must understand the good and the bad of getting a business a loan before you get entangled in a web of debts and high-interest rates.
You have to understand when you borrow money from traditional lenders there are conditions and requirements you have to meet.
Remember, when you get a loan from a lender you are assured you will still retain your business even when you fail to make timely loan repayments.
Also, you are assured of deductions on your business’s income tax and low-interest rates.
Weigh out the cons, too. When you take a business loan, you are forced to repay the principal amount as well as interest rates.
This form of funding will also impact the credit rating of your business. And often, collateral is required as a form of security.
As an entrepreneur, you have to understand the drawbacks and benefits of seeking financial assistance from traditional lenders.