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BFS Capital Blog

Are Small Business Loans a Good Idea?

February 2, 2017

In life, much as in business, there are problems, and there are money-solvable problems. An irrationally-angry brother-in-law who uses every holiday meal as an excuse to tell everyone why they should move to Iceland? Not solved by money. A small business in desperate need of some new equipment to keep up with demand? Money can help.

But even once you’ve identified problems that are money-solvable, the question remains: Is borrowing money going to make this problem better or worse? Small business loans exist to help businesses succeed, but many times business owners get them for the wrong reasons, and problems they thought would be solved spiral out of control. In determining if a small business loan is a good idea, you must first ask yourself some questions, and see if it’s the right fit.
Are you borrowing for growth, and not compensating for poor sales?

Borrowing money to make up for disappointing sales is kind of like drinking water to ease the pain of spicy food: It seems tempting as a quick solution, but ultimately makes everything a lot worse. If your company is profitable and you have decent cash flow, but you need funds to expand, then a loan is a good idea. If you’re not making money, and you need funds to pay bills and get through the month, it’s a terrible idea. Another payment on top of the ones you already can’t make is only going to sink you deeper.

Look at your month-end cash on hand to determine if you’re making enough to afford the payments on your loan. If that cash is 1.5 times the monthly payment, then you can afford it. If not, you might want to wait until a little more money is coming in.
What are you using the money for?

A small business loan should be looked at as a kind of investment. That is, it should not be squandered on things that will be gone soon. Not that anyone expects you to blow the entire loan amount on bottle service and rims, but even things like increased inventory can be ill-advised. Basically, anything that’s not going to give a long-term return on the investment isn’t something to borrow money for. This might also include employee incentives, customer rewards, or ongoing payments.

What purchases SHOULD warrant a small business loan? Large equipment that will increase capacity is a good example, especially because you’ll be using it as you pay the loan off. Hiring expenses to increase your staff, expansion into bigger spaces, technology and machinery upgrades and business acquisitions might also be good reasons to get a loan.
Have you exhausted other options?

You’re a small business, which means you have a lot of lending options. Perhaps you have friends or family that can loan you the money on more favorable terms. Or, if you don’t want to go down that road, see if any of them would be interested in investing in your company in return for future equity.

Angel investors or venture capitalists are also good sources of funding for long-term goals. It might cost you some equity and decision-making power, but it might also be the boost you need to take your business to the next level.

Outside of individuals, alternate loans like merchant cash advances, where you borrow money against future credit card sales, can be a faster way of getting a cash influx as well.
Do you have existing loans with unfavorable terms?

Remember 2008? Aside from the cultural advent that was the “Single Ladies” dance, it also began the greatest recession of most of our lifetimes. And those who were able to get loans during that time didn’t exactly get killer deals. Though the economy has improved since then, some business owners are still saddled with some pretty unfavorable loan terms. As of right now, terms for borrowers are pretty good, and it might make sense to refinance. With big changes coming to government soon, now might be the time to take advantage of better terms.
What is your plan?

Much like when you started your business, you’ll need a solid plan for what, exactly, you plan to do with the money you borrow. Yes, having cash on hand is nice, but if you don’t know what it’s intended for it will inevitably be wasted on a bunch of small stuff and impossible to show a return. Many lenders will ask for a plan, or at least an outline of where the money’s going. But even if they don’t, make one anyway. Draw out exactly where the money will be spent, and the expected ROI.

This will also help you determine how much money you need to borrow. Because getting as much as you can isn’t a good idea, ever. And having a strict budget in place before the cash comes in gives you the best shot at making the money work for you.
Are you making life better for your customers?

Quick-turnaround customer rewards aren’t always the best investment, and borrowing money for a short-term loss leader or crazy promotion is never advisable. But if you’re borrowing money to invest in customer service or upgrades to your facilities that benefit customers, then a loan is a good idea. This could mean modernizing your facilities, investing in creative talent to create a better product, or finding technology that streamlines the customer experience.

Finding an ROI on these sorts of things isn’t always straightforward, since making existing customers happy doesn’t always show up on your bottom line. So you may want to set some quantifiable goals that aren’t money-related, like customer satisfaction ratings or customer retention rates, to see if this is worth the investment.

Borrowing money isn’t always the solution to your business’ problems, but in the right situation it can be the energy you need to grow. An ill-advised loan can sink you even deeper, so always spend time looking at the ROI and plan out where the money is going to go. And if you decide it’s the right decision for you, BFS Capital has plenty of options to help you get where you want to be.