Definitive list of small business loan mistakes to avoid!

Almost every business needs to borrow at one time or another. However, there’s definitely a right way and a wrong way to go about getting a small business loan. Click here for a useful guide to small business loans

So what are the pitfalls you should make every effort to avoid when you’re seeking finance?

1Applying for a small business loan before you’re ready

Whilst your business could really benefit from an injection of cash from day one, you’ll need a track record and a solid credit score before banks want to do business with you.

If you’re a raw start-up with few if any assets, you may even find that alternative lenders, who tend to be much more flexible, are also quite reserved.

2Borrowing too little

It’s tempting to ask for less than you need in order to maximise your chances of acceptance, but what’s the point? If you don’t borrow enough to satisfy your original requirement, whether that’s to fund a marketing campaign, expand your team or premises, or simply overcome a cash flow hurdle, you’ll be back to square one and seeking more finance pretty soon.

3Borrowing too much

Conversely, if you borrow too much you’ll be paying interest on money you don’t really need, which will depress your free cash flow. Further, with many small business loans there are swingeing early repayment penalties, so handing the money back may not be a get-out-of-jail card.

4Failing to talk to both banks and alternative lenders

As already mentioned, banks and alternative lenders apply quite different criteria. Banks have become far more cautious in their lending policy since the financial crash of 2008, so alternative lenders such as Cashsolv will often say yes when the bank’s computer says no.

More broadly, talk to several lenders in both categories, so you know exactly what deals are potentially on the table.

5Comparing apples with oranges

A term loan (where you borrow a fixed amount over an agreed period and pay it back in monthly instalments) is not the same as a merchant cash advance (where you repay via a fixed percentage of your daily credit card sales) or a line of credit (where you borrow and repay at will against a credit limit, much like an overdraft).

You need to decide what will work best for your business, and equally importantly work out the total cost of each option. A simple interest rate will not give you this information, so you may need to press the lender to supply it.

6Not knowing what you will do with the money

Whilst it’s always nice to have a cash cushion on hand, you’re wasting money and wasting your time if you borrow without a clear purpose. It’s vital that you know what you want to do with the loan, and how much you will need to borrow to achieve that goal.

7Failing to provide the information the lender needs

Banks, in particular, tend to do a lot of due diligence before reaching a decision, so you may be asked to produce your articles of incorporation, balance sheet, three years’ profit and loss statements, tax returns, a business plan and even CVs for the management team.

Fail to assemble the paperwork they require and they won’t reach a decision, so you’re simply wasting everybody’s time if you fail to comply.

8Not being upfront about your business and its challenges

By the same token, never be tempted to massage your figures or gloss over your company’s challenges when seeking finance. At best, you may end up with a loan you cannot repay, placing you in a worse position than when you started; at worst, you could find yourself charged with fraud.

9Not maintaining a good credit score

If you want to borrow from a bank, a good credit score is king. The way to build your score is to borrow regularly and repay on time and in full, make sure you don’t become tardy with suppliers’ payments and not max out your business credit cards, which is a red flag for a company facing financial stress.

It goes without saying that it’s vital that you know your score. Many entrepreneurs don’t and, unbelievable as it may seem, go into financial negotiations blind. It’s even possible that there are mistakes in your credit history, providing another reason to check it regularly.

10Waiting until the last minute to borrow

In business, forewarned is forearmed, so you should always maintain a detailed cash flow forecast, which you update dynamically whenever something changes. If you don’t do this, you could find yourself needing a sudden injection of cash to avert a crisis and stay in business.

That rules out banks, for a start they can take weeks to reach a decision, and it could take you days simply to assemble the paperwork they require.

Alternative lenders should be able to help via an emergency loan, but you can forget about shopping around. You’ll have no choice but to take the first deal you’re offered.

11Not reading the small print

When you’re seeking to borrow a small business loan, attention to detail is a must. It’s entirely possible that a loan may have attractive headline terms but a nasty sting in the tail when you read the small print.

If your preferred financial solution has hefty early payment penalties, punitive sanctions if you miss a payment, or simply allows the lender to alter the interest rate at will, then you need to know about this before you sign on the dotted line.

12Failing to build strong relationships

People like to do business with people. Whilst many banks now have centralised approval procedures for business loans, your relationship manager may still hold considerable sway.

Don’t treat your bank or alternative lender as simply a supplier whom you approach when you have a problem that needs solving. consider it an ongoing relationship and update them on the business’s successes. That way, you’re much more likely to receive positive feedback when you need their help.

13Mixing personal and business finances

If you’ve got a young business with a poor or compromised credit score, it can be tempting to give a personal guarantee or take out finance as an individual.

This is a very bad move, for two reasons. First, once your business has become established, you may be able borrow 10 to 100 times more than you can as an individual.

Secondly, if you put your house on the line to secure a loan, then you could find yourself homeless as well as unemployed should the company collapse.

14Failing to make repayments on time and in full

It’s vital to remember that negotiating the loan you want is only the start of the process: you then need to make the repayments. Pay on time and in full, and your credit score should soar, giving access to further finance on more attractive terms.

Start missing payments and your score will plummet, significantly reducing your room for manoeuvre. Even worse, if you default on a secured loan, you could find a key asset being seized, potentially leaving you in a position where your business can’t operate at all.