With so many financing options on the market, finding one that meets the specific needs of your small business is no easy task. Now more than ever, small business owners must invest the time and effort in understanding what’s available in order to determine the financing option that makes the most sense for their business.
Knowing your lender and being clear about exactly what you are agreeing to is just as important as being able to secure the funding you need to grow. Small business owners often fail to do adequate research or miss the vital details when assessing whether to borrow or not, which can result in potentially costly mistakes.
Even the most seasoned entrepreneurs make mistakes. However, with April Fool’s Day just around the corner, we’re offering advice on how to prepare yourself in advance to avoid these five common financing pitfalls.
1 – Shop Around for Financing
One of the biggest mistakes a small business owner can make is to not thoroughly research all available financing options. A recent survey found that 58 percent of small business owners did not shop around when searching for loans. Chances are you wouldn’t purchase new equipment or renovate your office space without comparing vendors and pricing, and you need to apply that same logic to seeking a business loan.
There are numerous lending programs available to small businesses. Begin by identifying exactly how you intend to use your financing, and then look at options that offer affordable money with reasonable interest rates. If you don’t qualify for traditional financing due to lack of credit, poor financials, or limited collateral, there are viable alternative lending options to investigate.
When comparing small business loans, you will want to consider whether or not you meet the lender’s minimum requirements. These may include a minimum personal credit score, annual revenue and cash flow, and length of time in business. It’s also important to know if you need collateral, such as real estate or equipment, as security for repayment of the loan. If you are looking to establish good business credit, find out if the lender reports payment activity to the credit bureaus.
Not knowing all of your options can end up costing you more money in the long run, so it pays to put the time into doing the research up front.
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2 – Calculate your APR
There are a lot of numbers involved with a financing offer, from service fees to interest percentage rates. In order to truly understand the true cost of your loan, it helps to calculate the annual percentage rate (APR) when comparing competing offers.
APR tells you the actual cost per year of borrowing money, and it is generally higher than the advertised interest rate. Your APR takes into account the interest rate and compounding effect, and it includes additional fees and charges.
This is important to remember if you are calculating the rate yourself. Many business owners calculate APR as total fees divided by the amount borrowed, rather than calculating the interest based on the amount outstanding at every point in time (i.e. the amortized amount). The difference can be significant for small businesses.
A word about merchant cash advances: Jumping into a merchant cash advance (MCA) because the money is fast and convenient could cost you more over time than options such as a small business loan or asset-based financing. An MCA is one of the most expensive forms of financing with APRs that are typically in the triple digits.
The costs and repayment structure can make MCAs difficult to understand and contracts may include unfamiliar terms. For example, the specified percentage rate that appears on the first page is often confused with the interest rate. In fact, it has nothing to do with your borrowing cost. MCA providers also do not typically provide APRs. If a lender will not give you the information you need to calculate the APR, they may not have your best interests at heart.
3 – Read the Fine Print
Whether you choose a bank loan or online financing, it is critical that you understand what is in the details. In order to avoid surprises or costly mistakes, you must read the fine print before you sign on the dotted line.
According to the U.S. Small Business Administration (SBA), here are some things to look for in your business loan agreement:
- Whether the interest rate is fixed or variable, and how frequently you might expect rate changes with a variable rate loan
- Payment schedules, grace periods, origination, and late payment fees
- Prepayment penalties if you pay off the loan early
- The lender’s definitions of default and the penalties incurred
Also, be aware of extra fees or charges added to the loan, such as administrative fees, application fees, loan processing, and underwriting fees. These costs are sometimes hidden in the fine print and are important to consider before moving forward.
4 – Do Your Due Diligence
Do not assume that a lender is reputable simply because they have been referred to you or have a recognizable name. A clever advertising campaign is not an indication that a lender is regulated or reliable.
It is vital that you conduct due diligence on any lender you are seriously considering working with. This can be as simple as a Google search using the lender’s name followed by the words “fraud”, “scam”, or “lawsuit.” The Better Business Bureau is a good source for information regarding complaints made about unfair terms or hidden costs, and your local SBA office can help you determine a lender’s credibility.
With the rapid growth in online lending, it is important to keep in mind that these lenders are not regulated the same way as banks and other institutions. You need to make sure you are crystal clear on details such as the APR and cash flow implications. Many of these lenders focus on MCAs and their terms may be confusing.
Summit Financial Resources understands that developing relationships based on trust and respect is essential to creating a win-win for your business and for ours. In our experience, working with a lender who takes the time to get to know you and understand your business makes for a better partnership down the road. At the risk of sounding old school, we believe that meeting customers face-to-face is essential to this process. Our advice is to be wary of lenders who only have an online presence and do not offer the option for you to meet with a representative in person.
5 – Put it in Writing
We are often surprised when customers assume that their financing paperwork is not necessarily binding. Your loan agreement is a formal contract that will stand up in a court of law. Once you sign off on it, you can safely assume that if something is not in writing, it is not going to happen.
We can’t emphasize enough the importance of taking the time to read your loan-related documents in their entirety. Prepare a list of questions for your lender so that you have a clear understanding of the terms, or consult a trusted advisor like your accountant or attorney. In fact, we advise clients to have their attorney review their financing agreements. If changes are recommended, discuss them with your lender and be clear about how the changes will impact you ability to effectively run your business. Never assume that your lender will make every change you request, and review any revisions word for word.
As a small business owner, you know that financial mistakes are no joke when it comes to the future of your business. Summit Financial Resources is committed to helping you avoid these and other financing pitfalls and provide you with the working capital you need to thrive.
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Summit Financial Resources specializes in working capital financing for small to medium-sized businesses that need increased cash flow. We provide working capital financing through invoice factoring, asset-based lending, inventory lending, and equipment financing.