6 Costly Mistakes to Avoid for your Small Business When Considering Finance
As a small business, there could be any number of reasons you might get into trouble with a business loan. Financing a business should be done with thought and planning, you may be surprised to discover that more than 60% of Australian small businesses fail within 3 years.
Choosing the wrong type of finance, or failing to prepare thoroughly before you apply, can lead to mistakes that could cost you dearly.
Here are the top six business financing mistakes – and how to avoid them:
The most fundamental principle of business financing is to match the term of your loan with the type of need.
Using a short-term finance option like a business credit card or overdraft to cover a bigger debt can leave you paying hefty fees and compound interest for years, while you struggle to repay it. You also run the risk of defaulting on your loan, resulting in the facility being withdrawn, sending you scrambling for alternative finance. Taking out a loan with a fixed repayment schedule would be a far more prudent and economical way to finance a medium- or long-term need.
On the flip side, you don’t want to be locked into paying fees and interest on a long-term loan when you no longer need it – but some forms of finance incur heavy penalties for early repayment.
Creating a business case for your loan will help you to establish how much you need to borrow and for how long, so you can identify whether you need short-, medium- or long-term financing.
Missing out on tax breaks
Depending on the way you structure your debt, you may be able to offset some of the costs against your tax. The optimum debt structure for your business will depend on your specific financial position, so it’s vital to get professional financial advice during the planning stages, to help you make the right choices. There are also small business incentives offered via the Government that you should be aware of. Check out the Small Business section of the Budget above.
Choosing the wrong right type of finance
Your business case and thorough research are the key to avoiding the third costly error – choosing the wrong financing product.
For example, if you want to purchase equipment for your business you could apply for a business or personal loan, take out lease financing or enter into a hire purchase contract. The costs and the benefits vary widely – you could end up locked into a contract for an asset you no longer want, be stuck using obsolete equipment because there’s no option to upgrade, or pay for years for equipment that doesn’t belong to you at the end – so its crucial that you understand all the terms and conditions before you make a choice.
Each lender will also offer different rates, terms and conditions, so be sure to shop around and make sure there are no hidden costs or restrictive provisions before you select a product.
Using a loan repayment calculator is a simple way to assess your options. There are many business loan repayment calculator tools available online; so be sure to use one that is versatile, for example using one to account for a factor rate, a factor rate is one where the interest is calculated on the original loan amount and not on the balance remaining.
Not leveraging your collateral
The amount you’ll pay for your business finance all comes down to risk. The more of a risk you present to the lender, the higher the return they’ll expect in compensation. An unsecured loan will always be more expensive than one that is secured with property or assets.
Many SME’s simply don’t have anything to offer as collateral – which is one of the main reasons small business loans regularly get rejected. But if your business has assets, or the purpose of the loan is to purchase assets, you may be able to secure far more economical financing by using them as security.
Not building up a credit history
This one is all about long-term planning. It may seem like never having borrowed money would be a good thing, giving evidence good financial management. But having no credit history at all can be as damaging as a black mark against your name – lenders want to know that you can manage debt and meet the responsibilities of paying back a loan.
Building up a positive credit history for your business by taking out a smaller loan or arranging an overdraft facility may help you secure more substantial debt financing later.
View your business credit history at Dun and Bradstreet.
Not preparing thoroughly
Big banks in particular are all too ready to reject loan applications that don’t meet their stringent criteria. Before you apply, it’s crucial that you assemble all the documentation the lender is likely to need – which could include three years’ full financials, a business plan and a detailed business case for the loan.
Failure to prepare thoroughly could lead to long delays in the approval process, potentially costing you valuable business opportunities – or even to the rejection of an application that could have been successful, and a black mark on your credit history.
About the Author
Charlie Wilson writes for AuthorFlair he has been living and working all over Australia collaborating with other freelancers and start-ups. His background and success in small business has equipped him with a vast network of contacts and broad range of experiences within the Australian entrepreneurial scene. If you would like to hear more from Charlie, you can find him on Twitter