A capital infusion offers relief from chronic operating cash shortfalls but it may not always be the answer to the dreams of a small business owner
By: Nesa Rahmat/
On the surface, a loan can seem like the answer to the dreams of a small business owner. A capital infusion offers relief from chronic operating cash shortfalls and opens up possibilities for expensive upgrades and new products. But small business loans can create as many problems as they solve, because loan amounts need to be repaid, and new projects often cost more than an entrepreneur anticipates.
Capital infusion may be the answer for too much debt
If you underestimate the amount of money you need for a small business loan, you may find yourself saddled with extra debt without being fully able to implement the project for which you borrowed money. It is often easier to ask for a smaller amount than a larger one, because the risks do not seem as great to either the borrower or the lender. However, an insufficient capital infusion for a project that cannot get off the ground with the funds you have available can put you in a worse position than if you had never borrowed the money in the first place.
Can there be a problem of too much capital infusion?
If you have secured a loan that provides plenty of available capital for your small business, you may be in danger of spending money recklessly, without being sufficiently attentive to the returns. Too much capital infusion can be as much of a problem for a small business as too little, because you feel that you do not need to keep track of every cent as you are spending, yet, you still need to repay the loan when the money runs out.
Too much debt and capital infusion
When small business owners incur debt to cover start-up costs and company expansion, they run the risk of incurring liabilities that cripple their companies during future years, as they become profitable on paper but cannot get ahead because they have too much to repay. The successful repayment of a small business loan requires meticulous budgeting and cautious forecasting. Before taking out a small business loan, an entrepreneur should look at worst case scenarios, as well as optimistic ones to be as certain that he can repay the money he borrows.
ew experienced lenders would find this statistic surprising, because we’ve seen all too many times the mistakes that can be fatal to a small business.
However, entrepreneurs can dramatically increase their chances for success and avoid small business financial traps if they’re prepared for the problems they’ll encounter.
Whether they own restaurants, professional service firms, high-tech ventures or retail outlets, all entrepreneurs face common pitfalls. The following traps have been the downfall of many businesses and should be avoided by current or prospective small business owners:
Undercapitalisation. Small business owners often want to run their companies on a shoestring, and thus avoid borrowing money. But adequate capital is needed, sometimes suddenly, to invest in the materials, equipment, staff and real estate that will lead to profits and, hopefully, success. Small business owners should always allow for a safety margin when estimating their capital needs. Overcapitalisation can’t kill a small business, a capital shortfall can.
Ignoring business problems. A small business doesn’t fail overnight. There are always warning signs, and entrepreneurs must recognize and respond to them. Too many small business owners ignore cash flow problems, payroll shortages and other signals. When they finally approach a lender for financing help, it’s often too late, the business is in a hole too deep to escape.
Using the wrong type of financing. The relationship between the type of financing and its purpose should follow simple logic: long-term loans should be used for long-term investments, such as equipment, while short-term loans should be used for working capital. Repayment terms should always make good business sense. For instance, the owner of a construction company shouldn’t finance a new truck over 10 years. In that industry, the truck may be replaced in as little as four years, and the owner would be paying for an asset that no longer exists. This is one of the small business financial traps.
The biggest pitfall for small business owners is short-sightedness. Owners need to prepare for periods of growth, new product development, physical expansion, etc., well in advance — and consider every possible outcome of their actions before proceeding. In addition, they need a sound financial plan that allows for variations in capital requirements, equipment and real estate needs, personnel, marketplace demand, etc.
An experienced small business lender can be an invaluable resource for information about financing options, capital need calculation, personal finances, financial and estate planning, and other issues that are critical to small business success. Entrepreneurs should sit down with their lender at annual or semi-annual intervals to discuss what’s happened in the business recently, what the future holds, and what resources are available to manage the challenges of owning a small business.
One best small business loan tips most people won’t give you is to not wait until you are desperate to ask for money. This is one of the least known small business financial traps. The bank wants to feel secure in its decision. It does not want to hear that your business needs the loan to survive; it wants to hear that your business needs the loan to grow.
If you have no time to shop for best loan deals, the next best alternative is to use the services of loan specialists. There are many factors to consider when you have to haggle business loans, and loan specialists can always tweak terms to have an advantage.