Photo by Gabrielle Henderson
Taking a loan for your small business might be the biggest decision you have ever made. It’s important to get your facts together and make the best possible decision. Whether you are borrowing to save, sustain, or grow your business, you need to know these rules.
This article will take you through the following proven 4-step approach to get the most value out of borrowing money:
- Confirm your reason for taking a loan from the list below
- Understand the general rules for taking any business loan
- Learn the specific secrets for the reason you are borrowing money
- Make an intelligent decision and never look back!
The 3 Primary Reasons Business Owners Borrow Money
First, you need to decide which of the three reasons business owners borrow money applies to you.
1. To Grow a Successful Business
Your business is successful and you want to keep the momentum going. Below are some scenarios where you would take out a loan to become even more successful:
- Purchasing real estate for a new location
- Getting working capital
- Expanding Your Product or Service Offering
2. To Maintain a Stable Business
Maintaining a stable business is one of the hardest things for small business owners. Sometimes, an injection of cash is needed to ensure your business stays ahead of the curve. Some examples of when you would borrow money to maintain your business include:
- Remodeling or making improvements to basic infrastructure
- Upgrading IT equipment to current technological standards
- Expanding or improving aspects of the business to remain competitive
3. To Save a Struggling Business
Your livelihood is on the line and you need cash quick to keep your business from crumbling. Borrowing money to save a struggling business includes some of the following scenarios:
- Covering payroll
- Paying vendors who have stopped or threatened to stop servicing you.
- Paying for inventory or production costs.
5 General Rules to Follow Regardless of Why You Take a Loan
Now that you are sure of why you want to borrow, you need to follow these five rules before your business takes on debt.
1. Create a 6-month written financial outlook before getting the funds
Borrowing with no business plan for the next six months is a recipe for failure. Getting help to create and execute a realistic, data-backed business plan is one of the top reasons entrepreneurs seek small business coaching.
Make sure you have a documented plan for each of the following areas of your business:
- Investments & Marketing
- Human Resources
- Current Debt
- Vendor Contracts & Pricing
Your financial projections are especially important. Document how much you expect to spend in each area and exactly how that investment will turn profits.
2. Ensure you have a written plan for how you will pay it back
Some business owners have a vague plan to pay off their debt. “When the profits start rolling in” is not a good enough answer.
In addition to the business plan above, you need a clear plan to pay your loan back.
Map out exactly what date you plan to make your last payment. Having a clear repayment plan will keep you on the right track, no matter how long it takes.
3. Never use business loans to pay a non-business debt
It is tempting to take out a business loan when profits aren’t where they need to be and you have a personal debt to service.
The reason this never works is bad financial habits cannot be fixed by more money. Taking out more debt to pay down debt creates an endless spiral that you will never recover from
4. Don’t get tempted to make personal purchases with a company loan
One of the first things some small business owners do when they get a line of credit goes out and buy things they want, but not what their business needs. It’s often things like remodeling their house, getting a new car, or buying the boat they always wanted that eats up their funding.
5. Do not reduce your workload after securing business funding
The worst thing you can do is take your foot off the gas because your immediate money needs are solved. You’ve been working hard and you need a break, but keep it going for just a bit longer and this might be the last time you have to borrow!
You want to do the exact opposite. Right after securing a loan is when you want to work harder than you have ever worked. Paying yourself is the expense you can control the most.
Don’t take more profit because you are working more hours. Think long-term and turn the effort you are putting in now into more profit you could ever dream of six months down the line.
4 Questions to Answer Before Borrowing Money to Survive
Your profits are low and you have no idea how you can pay your expenses without a loan. Answer the following four questions to make sure borrowing money is the right decision.
1. What is the root cause of your financial struggles?
If you don’t identify the root cause of the problems that got you here in the first place, borrowing money will only be a short-term fix.
Then, you will eventually end up in an even bigger mess. If this weakness still exists in your business, it is only a matter of time before this new injection of cash vanishes.
2. Have you resolved this root cause or created a written plan to resolve it with the loan?
Getting your head above water is urgent, but stop and solve whatever you can without money.
In some cases there is no way to solve an issue without a loan, so create a strict written plan for exactly how you will solve it as soon as you have the money.
3. Are you committed to working even harder than you have been?
You probably feel exhausted by all of the stresses of having a struggling business. You want to just be able to enjoy some time off, but now is the time to dig in and work harder than you ever have!
Don’t lose hope. Think of how great time off will feel once you pulled your business out of the gutter.
4. Are you absolutely certain you need this money to survive?
Taking out a small business loan has to be your absolute last resort if you are struggling. Triple check your financials to make sure it is the only way to save your business.
Are you sure you have cut every single expense possible? Did you try every possible thing you could do to increase sales?
3 Questions to Answer for Before Borrowing Money to Maintain
Maintaining a stable business can get costly. Make sure to answer these three questions before taking out a loan.
1. Is this money absolutely essential to sustain the business?
Making improvements to your business feels great, but they have to factor into your profitability if you need a loan to make them happen.
If you are upgrading your IT equipment, for example, it has to be because you have to do it to make more money – not simply because you wanted new equipment.
2. Is there any way to get this money from an increase in revenue or sales?
Can you try running a promotion for the next 90 days? Make a big marketing push and incentivize your team to produce more.
Think outside of the box and see if you can come up with a way to boost sales and get the cash you need.
3 -Is it possible to fund this project by cutting expenses in the short term?
Think about the last time your business was in trouble. Remember how easy it was to make major cuts?
Maybe you can cut some of the same expenses temporarily. Consider eliminating non-essential roles and pausing monthly services that you don’t really need to succeed.
3 Questions to Answer Before Borrowing Money to Grow
We have all heard the saying “Grow, Grow, Gone”, so be careful that you don’t take on unnecessary risk by answering these three questions.
1. Is your business model built for long-term profitability?
You are profitable now, but do you have the systems in place to be profitable for years to come?
Building for long-term profitability requires you to have a systems-dependent business rather than a people-dependent business.
2. Is there any risk in your industry or the economy in general to consider?
Even if a business is great now, you still need to think about future threats to your business.
Is the economy unstable and heading towards another recession? Is there some risk threatening your industry that could cause a business to slow down?
Make sure these changes aren’t around the corner to keep yourself from getting blindsided.
3. Do you have enough profit to service the debt and interest?
When you do opt for a business loan, you have to know for a fact that you have enough profit to service your debt and interest. This requires you to have a strong understanding of your financials. Ideally, you have been doing a full financial analysis every month.
Create a growth plan and document how much funding each part of it will take to execute.
Taking a loan is a big decision and this article is designed to help you make that decision, but consider talking with an expert small business coach before you sign that dotted line. Someone with real-world business experience who has been right where you are now can give you insights that you may not be able to get on your own.