Business loans: Dos and Don'ts

Albeit challenging, running a business is a truly rewarding experience. Not only in terms of the profits but also the fulfillment you get at the end of the day knowing you are your own boss. You get to make the rules. I mean, who doesn’t want to be the one to run the show?

However, this also comes with a lot of responsibilities. As the boss, you are in charge of different tasks concurrently. Sometimes, you are fully responsible for bringing in the business, running the day-to-day business logistics, and also arranging the required business financing from time to time. 

One type of business financing you might need to consider is a business loan. At first glance, it might look like a business loan is a tap-and-go option, but it can be challenging to navigate. 

Therefore, it is prudent as a business owner to fully understand the dos and don’ts of business loans to get the best out of them. After all, the richest people often get ahead by being great at using other people’s money to build their wealth. 

To help you along the journey, here are a couple of dos and don’ts that you should bear in mind while thinking about applying for a business loan. 

Business Loans Dos

1. Borrow what you need, when you need it (Borrow at the right time)

Just because you qualify for a loan or a higher credit line doesn’t mean you should use it. A business loan should only be used strategically to help grow business revenue. Not to fund just another random business expense that was not planned. 

Learn More: 10 Smart Reasons to Take a Business Loan

Plan carefully, and then borrow the right amount at the right time for the right business project. Also, do not miss a chance to grow your business because you missed the right chance to borrow. Plan appropriately and borrow when you need to. 

2. Do your due diligence and understand your lender (compare lenders)

Unlike yester years, you no longer need to only rely on your bank to get a business loan. So before you settle on a lender, ensure that you do your due diligence and pick a lender who best resonates with your business needs. 

Shop around for the best terms and ensure that the lender you choose has a rock-solid reputation and best meets your needs. 

The good news is that you do not really have to do all the shopping on your own. Money254 has done all the hard work for you and created the various Money254 Business Loan Finder where you can compare the business loans available to you on the terms that matter most to you and settle on a lender and product that helps you meet your business needs. 

3. Know your elevator pitch

When talking to a lender, you need to be able to convince them that your business is capable of repaying the amount borrowed. 

So your pitch should be able to tell your track record, your future plans, what makes you a good match with the lender, etc. Most importantly, you need to clearly be able to pass this message across. 

Learn More: 8 Reasons Your Business Loan Application Will Be Rejected

4. Prepare your paperwork beforehand

Every lender has a bespoke eligibility evaluation process that is hinged on your providing documented proof from the applicant. These documents help the lender understand your business better and gauge whether you qualify for financing or not and for how much.

The first impression counts. Prepare the paperwork beforehand to ensure that you have everything ready. A well-prepared application gives the lender a good impression - confidence in your abilities and your company. A missing crucial piece of information could jeopardise your application. 

5. Prepare a budget and follow it

The foundation of a good business loan is a good budget. In most cases, it is what the lender will use to determine the amount to lend you. However, the importance of a good budget starts even before you send in your application.

If you have prepared your budget correctly, it tells you the exact amount to borrow so that you do not go too low or too high. And it does not end there. Once your loan is approved, ensure to follow the budget strictly. 

6. Keep track of the numbers.

Don’t leave all the bookkeeping to the accountant. Instead, watch the numbers like a hawk and ensure to keep track of every shilling that is going in and out of the business. 

Also, sometimes entrepreneurs forget to separate personal and business finances. Ensure to keep these separate and diligently keep track of the business financial records and ensure that everything is as it should. This way, you can track how the business is performing and make changes when necessary. 

Business Loans Don’ts

1. Don’t fudge the numbers.

It could be counterintuitive (if not illegal) to fudge your projected financial statements. Before you present the projected budget to the lenders, ensure it represents the actual status of your business. 

Review the numbers against the daily business situation and adjust accordingly without overstating it. 

Ensure you do not overstate the income or understate the expenses to try to impress the lender. It can be a suicidal move for the future of your business. 

2. Don’t focus on interest rates only

It is important to understand the loan interest rate before you apply for a loan. However, do not focus too much on them such that you forget the fact that many other fees together with the interest rate constitute the total cost of the loan i.e. what you will eventually pay the lender for giving you the loan. 

Other things to consider before deciding on a business loan include;

• Whether the lender charges an application fee. Some lenders charge up to Ksh15,000 in application fees which could significantly increase the total cost of your loan.
• Does the lender charge a processing fee and how much? While some lenders may use the terms processing fee, negotiation fee and application fee interchangeably, a good number may charge an application fee and processing fee separately. Money254 research shows processing fees range from 0% (not charged) up to 15% of the borrowed amount for some lenders. The average processing fee charged by the lenders who have this fee is 3%. 
• The implication of the interest structure on the total cost of the loan is also worth considering i.e. flat rate versus reducing balance. 
• How much the lender is willing to lend based on your needs. Some lenders are only willing to finance a fixed percentage of the project budget. 
• The bank’s flexibility on repayment. Some lenders give a grace period on the principal repayments and allow you to pay interest only for this period. 
• What are the guarantees that the lender requires? Some lenders need you to give a personal guarantee. 
• What is the loan period?

3. Don’t pay back the loan too fast

While it is a no-brainer that clearing debt as soon as one can will get you quickly out of debt and allow you to save more, this is not always true, especially for business loans. 

Repaying a loan too quickly can potentially harm your business cash flow. If you are using too much of your operating capital to service debt, you could be hurting your business growth since you are left with little to run everyday operations.  

It could actually negate the reason behind getting the business loan in the first place. You took out a loan because you didn’t have enough money in cash to make the purchase, hire an expert, fulfil orders or expand - if you pay it back too quickly you could go back to the same situation again. 

Although repaying a loan quickly can reduce the interest payable - especially a loan that attracts interest on reducing-balance - sometimes it can leave your business grasping at straws. 

Hence, before you consider repaying the loan quickly, check if your business cash flow can support it and if the interest saved is higher than the projected return on investment if you follow the loan term. 

It is possible that some lenders may penalise you for repaying the loan out of the agreed schedule. Also, lenders may still charge you the full interest amount you would have paid for say a 2-year loan even if you repay it back in six months. 

4. Don’t take out more than one loan at a time

Sometimes you might be in a position where your business needs an urgent capital injection and a business loan is the only option at hand. In such instances, you might be tempted to apply for two or more loans at once to maximize your chances. 

However, this is a very risky endeavor that can easily put your business at risk. Take out just one loan at a time.

5. Don’t put crucial business assets at risk

Before you settle on a lender, ensure that you have done enough research to see the options available to you. Check for lenders who provide unsecured loans options. Consider taking loans that will not jeopardise your business assets and put your business continuity at risk. 

No collateral means that your crucial business assets are not at risk in case of any eventualities. You will, however, sometimes need to take a secured loan to either qualify for a larger amount or because the lender requires so. Choose what you give as collateral carefully before putting a crucial asset at risk. 

WRAPPING UP

Finding the right loan option for your business can be daunting. However, before you even worry about that, it is crucial to know the main dos and don’ts to help you successfully navigate the landscape of loan application and repayment.  

Remember you are using a business loan as a tool to increase the success of your business, make profits and build your wealth. You must always make sure the loan supports the immediate, short- or long-term profit motive before signing on the dotted line.