Advantages and disadvantages of financing your business with borrowed money
Growing your business with borrowed funds can be a good idea. But getting into debt more than you should be could cause a serious problem. Here are the advantages and disadvantages of this form of financing.
- It allows you to build your credit. By making your loan payments on time, you can build your credit score.
- It allows you to establish a relationship with your lender. You can request a small amount of money even if you don’t urgently need the funds. This will help you build a relationship with your lender, a partnership that could come in handy when your business needs the funds.
- It can help you expand your business quickly. Borrowed funds give you the extra money you need to make your plans and ideas come true.
- It can improve revenue. Imagine a scenario when an entrepreneur takes out money to acquire new machines. The money earned from the sale of products made from the new machinery could be used to pay off the loan. Without the funds loaned, this additional benefit would not have been possible.
- Interest. This is the downside of taking out a loan. Of course, you should expect to have to pay a fair interest rate. However, loans with very high-interest rates can impact earnings.
- Obligation to present guarantees. Some lenders will require the borrower to present some type of property or asset to guarantee the loan. This can be a deciding factor for a small business owner who cannot provide guarantees.
- Delay. Many loan providers may take several weeks (or even months) before approval. Applying for an SBA loan may take a longer process.
- Time and effort (and expenses). For a proper loan application, there is a need to gather financial statements and other relevant information from the last two years or more. You may need professional help to put your documents in order and help you with the paperwork.
Should Your Invest With Borrowed Money?
How much should you borrow to invest in your business?
Finally, if you elect to take out a loan to invest in a business, the question is how much should borrow.
The first step you should take is to find out how much to invest in your business. To find the answer we advise you to go step by step:
- Define your business objectives.
- Decide how much investment it will take to reach each goal.
- Remember that you should not borrow more than necessary. Too large a debt can only cause you problems. The golden rule for deciding the maximum loan limit dictates that your monthly loan payment should not exceed 80% of your net earnings. This will provide you with a safety net in case you have an emergency or your cash flow goes down.
Tips for borrowing money to finance your business
If you decide to go ahead and borrow money, there are some precautions you should take:
- Do not borrow more than you need, you could get into too much debt.
- Make sure that your company can generate enough cash to pay the loan it takes.
- Use the funds borrowed exclusively for your business. Don’t invest in non-productive assets.
- Select your lender carefully. The wrong choice can lead to high-interest costs and lower profitability.
Borrow the right way
- Choose a lender that offers low fixed interest rates. You can start by requesting a quote. This process will take only a few minutes and will not affect your credit score.
- Choose a money lending company that combines the advantages that self-financing and external financing can offer you, as well as free and no-obligation advice from a commercial loan specialist.