— January 19, 2018
If you’re planning to start a business, or if you’ve started one but have fallen on hard times, you might consider getting a business loan. If your business has a few years of successful financial exchanges under its belt, or if you have a strong enough personal credit history, you shouldn’t have a problem getting a loan.
But for most businesses, getting a loan isn’t the difficult part, nor is it the part that requires the most forethought. Instead, business owners need to consider the right timing for getting a loan, as well as the right reasons for getting one. So what are the “right” motivations for taking out a loan, and how can you tell if the timing is sufficiently appropriate?
Different Types of Business Loans
Business loans may seem like they’re all the same; after all, they all serve the same purpose, and all need paid back eventually. But there are actually several different types of loans that you can get:
- Installment loans. Installment loans are the most “conventional” type of loan. You’ll receive a pre-defined sum of capital, which you’ll pay back in monthly installments that cover portions of the principal and interest. Rates, terms, and conditions vary significantly, but all of them follow a basic model. Depending on the specs of the loan, there may be penalties for early payments, or extra fees to watch for.
- Lines of credit. Lines of credit are some of the most common types of business loans, thanks to their convenient structure and long-term accessibility. A line of credit is a longstanding “floating” sum of credit that your business can access, much like a credit card. You can spend money using this credit, paying it back with interest gradually or all at once—however you see fit—until the credit limit is reached.
- Balloon loans. Balloon loans grant you a sum of capital initially, much like installment loans, but throughout the monthly payments, you’ll only pay interest on that principal. On the final day of the loan, you’ll be required to repay the principal in full. It’s ideal if you want to minimize your monthly expenses for as long as possible.
Loans may also be categorized and altered based on variables like the following:
- Secured vs. unsecured loans. If your credit rating is low, or if you want to get better rates, you may seek a “secured” loan, which gives the lending institution a piece of collateral of comparable value to the principal of the loan. For example, you may secure your loan with a piece of real estate or equipment, which can be reclaimed by the bank in the event of non-payment.
- Term loans. Term loans are good for a specific period of time, which may be a period of a few months, a period of several years, or anything in between.
- Accounts receivable loans. If you have accounts receivable pending, you may be able to get a short-term loan for their payment; you can collect payment from the bank early, and pay the bank back when the money from your clients comes in.
- Personal loans. If your business doesn’t have much credit of its own, you could feasibly take out a personal loan to cover your business expenses—so long as you’re prepared for the possibility that non-payment could harm your personal credit.
Because most loans are custom-fitted to the business requesting them, it’s usually possible to build the perfect loan for your situation, assuming you’re getting a loan for the right reasons, and are timing your move correctly.
Good Motivations for Getting a Business Loan
These are some of the most appropriate situations that demand a business loan:
- If you’re starting a new business, you’re going to need all kinds of things, including office space, equipment, inventory, and some people on staff. For most businesses, that means investing tens of thousands of dollars right from the start, and thousands of dollars a month before you’re able to start generating revenue.
- If you have a successful business in one location, why not expand it? You could invest in developing more products, marketing yourself to a wider audience, or even opening multiple locations in other cities. It’s a no-brainer for most successful business owners (assuming they want bigger profits), but you need to spend money if you’re going to fund that expansion. A loan could give you everything you need to get your new systems up and running.
- You may also need a raise to secure more talent for your business, or reward your current staff members to ensure they remain on your team. This is related to expansion, since both involve getting your business to do more. However, hiring more and better talent is more about finding creative solutions and coming up with new ideas, while expansion is more about executing an idea that’s already in place.
- New credit. If your business is still fairly new, or if you’re interested in developing a richer credit history, you may consider taking out another loan. The only way to build credit for yourself as a business is to make consistent payments on some kind of loan or debt, so taking out a loan for those purposes isn’t a bad idea—especially since you’ll be confident in your ability to pay the loan back.
- Equipment or inventory. If your business needs new equipment, or wants to invest in newer, more efficient equipment, a loan could be the perfect answer. Depending on your preferences, you could use the equipment itself to secure the loan, netting yourself a better rate in the process. The only caveat here is that the equipment shouldn’t be superficial; it should offer some measurable benefit that improves the productivity or profitability of your business.
- You may also consider getting a loan for an interesting business opportunity that isn’t otherwise specified on this list. For example, you may have the chance to acquire a smaller competitor, or purchase the assets of another business. Again, the main requirement here is that you’re using the loan to invest in something that has measurable potential to earn you a return in excess of the principal and interest you’ll pay on the debt over time.
Bad Motivations for Getting a Business Loan
However, you may be tempted to get a business loan for the following motivations, which could set you up for failure, or portend a poor fate for your business:
- Shiny objects. Just because something looks like a good opportunity, doesn’t mean it is. If you’re going to put your business’s credit on the line, and take on thousands of dollars of debt, you need to be sure this is going to yield long-term value for your company. A fleeting opportunity or investment, without the due diligence to back it up, will likely do more harm than good for your company.
- Credit pressure. If all your current loans and lines of credit are maxed out and you’re still having trouble, taking out yet another loan probably isn’t the solution. Take a look at the debt you already have, and examine why it hasn’t been enough to yield an effective return. Where was the flaw in your previous decision?
- Impulsive debt consolidation. Debt consolidation can be helpful, but it can also leave you in an even worse position. It’s true that you may be able to get a better rate, at least temporarily, but your business has bigger problems to consider. How did you get into this situation? How are you going to get out of it? More loans aren’t necessarily the answer.
The Effects of Timing
Assuming your motivations are sound, there’s a chance you could still time your loan incorrectly:
- Too early. If you get the loan too early, before you’re ready to use the money, you’ll spend more time making payments, and you’ll delay your ability to pay the loan back. If you strike prematurely, you may also have less information, and therefore will be more prone to errors in your financial projections.
- Too late. If you get the loan too late, you may struggle to make ends meet when you take on your new asset or responsibility. In cases of significant company financial strain, it could pose an existential risk to the business.
- Just right. Ideally, you’ll get the loan just ahead of when you plan to use the money, with enough time to settle and use the funds appropriately.
Is It the Right Time to Get a Business Loan?
Judging whether it’s the “right time” to get a loan is complicated and requires a thorough understanding of the type of loan you’re interested in, your current financial position, and what you hope to do with the money. If you’re using the loan as a last-ditch effort to save the company, or in response to an impulsive whim, you should probably rethink your approach. Otherwise, the “sweet spot” is sometime shortly before you actually need the money, once you’ve forecasted exactly how much you need and when.