Every business needs extra cash from time to time, and there are plenty of good reasons and loan justifications to take on debt: to launch new products, expand your business, or purchase needed inventory. Even though every business needs extra cash and so make loan justifications, there are also plenty of bad reasons to take out a loan. Here are five.
By: Hitesh Khan/
1. To launch a new business idea before you have thoroughly researched it. Fads come and go; the goal is the find one that sticks. Before you decide to buy into the latest fad concept, spend some time doing market research and deciding whether or not the concept is a good match with your experience and interests. Many people think that owning a restaurant is glamorous but find out later that it is very hard work.
Although every business needs extra cash, you have to do your homework and do loan justifications before you take on a serious financial commitment.
Personal guarantee is an inherent part of obtaining small business loans but there are many ambiguities and misunderstandings that surround the topic of personal guarantees. A personal guarantee is an unsecured promise from an individual to make loan payments when a small business is not able to do so. “Unsecured” means it is a promise that is not backed up by a specific asset, such as real estate, in which case, the asset would be considered collateral.
A personal guarantee is an added assurance that you are serious about your business – and most importantly – serious about repaying the loan. One big reason why a personal guarantee is needed is because most lenders are bankers and are in the business of accepting deposits. They use those deposits to make small business and other loans, and, as a result, they are responsible for protecting the interests of their depositors.
Be mindful that while your small business may be a borrower, you are also a depositor. As such, you would be affected if an unscrupulous small business owner borrowed your company’s deposits and did not bother to repay them.
A personal guarantee is a psychological reminder to you of your company’s obligation to make timely payments and eventually repay the loan. If it fails, you are responsible. A personal guarantee shows your commitment to being a responsible business manager and repaying your business loan.
Every business needs extra cash and the financial affairs of a small business are commonly intertwined with the personal financial affairs of its owners, so it is logical and reasonable to ask you to promise to repay the loan, if your company cannot. A personal guarantee offers lenders the ability to follow the due process to recover the business loan from you personally.
2. Your credit cards and lines of credit are maxed out. Even though your business needs extra cash, if you have exhausted all other available credit, maybe taking on more debt is a bad idea. When lenders see that you are overextended, you will likely be required to secure the loan with assets. If you are having difficulty paying your existing financial obligations, you are entering risky territory by gambling with your facilities, inventory, equipment, or even worse, your own house.
3. To make an impulse buy you can’t afford. Perhaps there is a new technology or machinery you think would benefit your business, or maybe you want to remodel or upgrade your facilities. While all of these things may prove advantageous to your business, you won’t be able to reap the rewards if you have leveraged all of your assets and the extra profits you make go toward repaying the loan. If the idea doesn’t bring in extra revenue, you are still responsible for paying back the loan. If you used assets to secure the loan, you may end up without a business at all.
4. You saw an advertisement or received an email about unbeatable interest rates. As the old adage goes, if it sounds too good to be true, it probably is. And on the outside chance that it is true, just because you can get a great interest rate doesn’t mean you should.
5. You want to consolidate your debts but haven’t learned how to budget. Maybe your company is going through a tough time, or maybe you have mismanaged your company’s finances and are now looking to consolidate all of your debts. Debt consolidation may ease the pressure temporarily, but you need to address the underlying problem if you want your business to succeed.
Knowing how much extra cash you need involves choosing from a vast array of alternatives. Debt or equity? Secured or unsecured? Are you at start-up, already launched, profitable, looking for exit / succession funding? How much resources have you committed to growing business funds?
Probably the most common mistake we find among those seeking financing for their business is the idea that someone else will stake them to their dreams without them taking a large share of the risk.
Think about it – how much confidence will a lender or investor have in your proposal if you don’t have enough confidence in it yourself to put your own resources at risk? So, the most basic rule of financing business is to commit yourself and your savings or resources to the business.
For a start-up business, which might not be able to obtain funds on credit, the owner will have to come up with capital, such as from personal savings. No matter where else you look for funding, the money you put in is a strong sign of good faith and commitment to other lenders. Your personal loan justifications will tell you that borrowing from friends and relatives and /or selling off surplus assets to provide the funds you need is sometimes more prudent.