Small Business Brief

Financial Services

5 Common Business Loan Mistakes and How to Avoid Them

Are you preparing to take out a small business loan?

Debt financing isn’t the best way to raise money for your business, but it’s still a preferable option, given the relative ease of accessing credit. Perhaps you’re in a cash crunch as a result of the COVID-19 pandemic, or you need money to finance a big order that just came in, or you quickly need cash to pay your workers.

Regardless of your situation, it’s important to know some common business loan mistakes you need to watch out for. If you don’t, you could end up making costly mistakes that could cripple your business down the road.

Keep reading for deeper insight:

1. Failing to Capitalize on Other Financing Methods

Taking out a business loan should be your measure of last resort, really.

You see, debt can be expensive. In addition to the money you’ll borrow, you’ll pay interest, which, depending on the terms of your loan, can be a substantial amount.

There are risks, too. If you default on the loan, the lender can come after your assets, especially if you took out a secured loan.

This is why the first business loan mistake you can make is failing to capitalize on other funding methods that aren’t as expensive as debt. For example, if you’ve got someone who can invest in your business, you can give them a share of the business in exchange for their money.

Equity financing doesn’t carry any repayment obligation. You’ll only lose a part of the company, which means the other investor will be entitled to a share of your profits.

In short, if you have anywhere else you can get money for your business, pursue it before you think of going in for a business loan.

2. Borrowing Less or More Than You Really Need

At this point, the assumption is you have no choice but to take out a business loan.

Nothing wrong with this. However, don’t make the mistake of borrowing less or more than you really need.

If you borrow less money, you might be forced to go back in for another loan. Your current lender might be reluctant to lend you more money while the other loan is yet to be paid. Even a new lender will decline because you already have another loan you’re servicing.

Let’s face it, though. You’re not likely to borrow less than you really need.

In any case, you’re more likely to borrow more than you need. If your business has an excellent credit score and it’s making good profits, most lenders won’t put a tight limit on how much you can borrow.

This isn’t an invitation to overborrow. Borrowing more than you need will unnecessarily cost your business because of the interest you’ll pay. 

There’s also another scenario. If you borrow way more than you need yet your business can’t prove that it’ll be able to service the loan, your application might be rejected. This isn’t what you want.

Before going in for a business loan, assess your needs and establish a near-accurate estimate of the amount of money you need. A small business consultant can help you do this if you’re not able to do it on your own.

3. Not Knowing the Different Types of Business Loans on Offer

If the only loans you have borrowed before are online payday loans or auto loans, you might not know much about the business loan market.

There are different types of business loans, as fleshed out below:

  • Term loans
  • Working capital loans
  • Equipment loans
  • SBA loans
  • Business lines of credit
  • Merchant cash advance
  • Commercial mortgages.

When you know the various types of loans on offer, it’s far easier to choose the loan that best suits your needs. This also reduces the chances that your application will be declined.

For example, if you’re looking to borrow money to buy manufacturing equipment, you shouldn’t be going in for a term or working capital loan. The right loan for you is an equipment loan. It’s easier to qualify for equipment financing because the money is secured against the equipment.

Knowing the purpose of the money you want to borrow is key to identifying a suitable loan. If you want money to buy or build a working space, for instance, how about going in for a commercial mortgage?

Of these loans, you certainly want to give SBA loans a deeper look. They’re offered by the federal government through select banks, and they carry lower interest rates than commercial loans. If your business qualifies for an SBA loan, go for it.

4. Failing to Shop Around for the Best Deal

There are tens, if not hundreds, of lenders that are willing to make a loan to your business, as long as you meet the basic requirements.

These lenders aren’t created equal. Some have great customer service, others not so much. Some have quick approvals, others take their sweet time, much to the annoyance of the applicant. Others charge higher interest rates.

When you want a business loan, it would be a big mistake if you avoided shopping around and comparing multiple loan offers.

Don’t settle for the first lender that approves your application. It might not be the best offer.

5. Waiting Until It’s Too Late to Apply for a Loan

Most entrepreneurs know that a business loan isn’t the best option. However, if you need money, you shouldn’t keep chasing other options if they don’t look promising.

If you do this, you could wait until its too late to apply for a loan.

No, nobody will lock you out from applying for a loan, but you’ll be under too much pressure and you might not be in a position to go through things with a clear mind. Rushing through applications increases your chances of making basic errors that’ll only get your application denied.

What’s worse, you could easily settle for an expensive loan because time isn’t on your side. Had you started earlier, you could have had enough time to shop around, assess offers, and settle on the best loan.

Avoid These Business Loan Mistakes

A loan, as long as it is utilized prudently, is a good way to raise business funds. If mismanaged, or if you make any of these business loan mistakes, there’s a chance your loan will be a source of regret in the near future. Try your best to avoid these mistakes.

Keep reading our blog for more small business tips.