What Are The Benefits and Risks of a Business Loan For Your Startup?
One of the quickest ways to boost finances and cash flow in a startup is to acquire a loan. While this strategy comes with its own share of risks, it can be the difference between making and breaking your business. Where all other options are unavailable, you can use loans to jumpstart vital operations and get your business back on its feet. Even then, it is always crucial to weigh the value of taking the loan against its total cost or implication. Put otherwise, only borrow when the benefits outweigh the risks.
So what are some of the benefits and risks associated with business loans? We explain both in detail in today’s post. As a bit of extra reading,Iwoca a UK loan provider has put together this guide to the top 10 business loans around at the moment.
Benefits of taking business loans for your startup
Increase business fluidity
A common challenge that most startups grapple with is limited funds to back up key operations. The high cash outflow going to investment expenditures and low returns as the business gets off the ground are often responsible for this imbalance.
Loans can help to increase the working capital and as a result, allow your startup to effectively manage its initial expenses. You can use the money to purchase important assets that your business needs to generate revenue. This is key in boosting the capacity of your new business to deliver in areas that were otherwise stalling.
Long repayment period
Unless you’re applying for an overdraft, most business loans come with reasonable repayment periods. What’s even better is that you don’t need to pay the funds in a lump sum. The majority of Business Loan lenders will allow you to service the loan in smaller amounts spread over several months. This lifts the pressure off your startup and allows it to pay as it thrives.
Tie to assets
If your startup is a limited company, chances are that if it ever dissolves, creditors can only recover the borrowed money from the business assets. What this means is that your personal assets are safe from auctioning if the business is unable to continue. In such a case, the financier only takes the collateral which you offered during the loan application. This could be the building that houses your business, equipment, or even a takeover of the business itself.
Loans are insurable
No matter how much effort you put in to ensure your new business grows and becomes sustainable, forces beyond your control can sometimes knock you down. This is why today, it’s not uncommon to find insurers willing to pay back your money lender should such risks occur to your startup. This gives your business a reliable guarantor to cover for you when the unforeseen strikes.
Power to seize opportunities
A loan offers quick finances to act on opportunities as soon as you identify them. This way, your startup can enjoy an edge over the competition and probably start off on the right foot. What’s more, when the money is put to good use, it becomes easier accomplishing goals in time.
Risks of Financing a Startup
Startups can fail
When you’ve established your business on borrowed money and it fails, a lot of things can go wrong. Your creditor may be forced to seize assets – including those that you have purchased using your own finances besides the loan money. Of course, this can be devastating especially if your collateral has more value than the loan itself. Additionally, you risk losing your credit score regardless of how little the loan amount was at the time you defaulted.
Vague clauses in loan contracts
The majority of creditors are very cunning and will rarely be on the losing end when you’re unable to repay your loan. While drafting the terms and conditions, some include clauses meant to protect them from any losses. For example, they may design the interest rates to be dependent on the market performance of the currency. This way, you could end up paying more money than you would if you used alternative funding methods.
When starting out, your new business will likely demand more money than it can generate in the short term. Indeed, this is probably one of the primary reasons for borrowing to keep it afloat. During this period, the temptation to use the borrowed money to cover ongoing expenses instead of boosting your capital can be overwhelming. Needless to say, this is exactly why quite a significant proportion of new businesses end up collapsing in just a few years of operating.
When you’re late to pay loan interests, your creditor is permitted to penalise you depending on the agreement both of you had. This can destabilise your already strained finances and negatively impact the growth of your startup. Besides, your credit record may begin to suffer thereby limiting your chances to borrow more funding from other sources in the future.
Have you used loans to start or boost your small business? Did you benefit from it or did it put you in more problems? We’d love to hear your feedback.