Four Business Financing No-Nos, by Morgan Leu Parkhurst
You have plans to open a business. Or maybe you can see a business expansion on the horizon. If only you had the money to do it. On the quest to market your business like crazy it’s tempting to go great lengths to obtain the cash you need to do the things you want. But, not all loan options are created equal. Below are a few that might make you think twice before signing on the dotted line.
- Borrowing on a credit card. This is a huge no-no. Credit cards are designed for short-term borrowing. Not long-term financing. Their high interest rates make them a poor match for a start-up business that may not generate revenue right away. There are a variety of loans available through banks that are better suited for start-ups and businesses that are trying to expand. When working with a bank, make sure to ask for the banker in charge of commercial lending. They are often in-the-know about loan options for businesses and can work with you to select the loan that’s right for you.
- Taking out a home equity line of credit. This is a no-no for a few reasons. One, if you are trying to pay down your mortgage to eventually own your home, it doesn’t make sense to borrow against the equity you already have. When you borrow against your home, you move farther away from accomplishing your goal of home ownership. If that doesn’t sway you against taking out a HELOC, perhaps this will. The second reason not to borrow against your home is if you default on payments, your home could be at risk. In addition to paying your mortgage, you are now paying on a second loan. Missing payments on either could land you in foreclosure. The final reason not to rely on a home equity loan is that if the value of your home is reduced (as we saw happen in recent years), your available credit could be reduced. As a result, you could be left still scrambling for available cash.
- Borrowing from family. My great-aunt, Auntie Wanda, always used to say, never sell a car to another family member. As luck will have it, the car will malfunction as soon as it switches owners. Imagine that family reunion. What does this have to do with borrowing money for a business? Well, if bad blood can build between family members over a used car, imagine the stress that results from a business loan. The minute the loan is transacted, the business will have a bad month or two or three. If you find that borrowing from family is your only option, treat it like you would any other loan. Get everything in writing, establish an interest rate, and create payment terms. You may want to have a lawyer look the agreement over to ensure everything is handled appropriately. If someone balks at the formality, consider yourself red-flagged and look for another loan option.
- Pawning items you own. This isn’t as common as the other three, but for people who want cash fast, this starts looking more and more attractive. Pawning, like credit cards, is a short-term loan. It isn’t designed for long-term use. Typical payback time is approximately 30 days. That’s not a lot of time to generate revenue. You’d likely have better luck with a garage sale. At least the money you make isn’t a loan. Although it’s easy to dream that cash will come flowing in, it doesn’t always happen. Make sure you are realistic about what your business can feasibly bring in before signing on any dotted line.
All loans aren’t inherently evil. They are also not equal. Unfortunately many people get themselves into situations they don’t understand or fully appreciate. Whether the business has a good or bad month, the money must be paid back with interest. There are alternatives to loans such as working a part-time job or expanding slowly as revenue comes in. Ultimately, as the business owner, it’s your call as to how much risk you are willing to shoulder. But carefully review your options before proceeding with any loan (either one listed above or otherwise). Your business and personal financial stability rely on it.
By day Morgan Leu Parkhurst helps individuals put the pieces of their marketing puzzles together. By night she teaches marketing communications to aspiring entrepreneurs. Reach her at sharpmindmarketing.com or on Twitter at @. Morgan_LP
Some of the best businesses we know we’re started use one or more of the “No-Nos” listed in this post. The reality is that financing a small business or startup is often difficult, and the options mentioned above are often some of the only choices entrepreneurs have. The real question that needs to be asked is how much potential opportunity is being sacrificed by under capitalizing the business. If that potential risk outweighs the potential reward, then these funding choices above should be seriously considered.
Just one anecdote…Last week I listened to the founders of a company explain their long working capital cycle. They had no other choice but to take every credit card offer they received in the mail and apply. They received a total of $250k in combined credit limits and used it all to grow. A few years later they had built a business doing over $50 million in annual sales. The CEO won the Entrepreneur of the year award, and their business has long since been cash flow positive. Yes, they paid off the credit cards as soon as they could. But they never would have been able to realize their potential without them!