So, you’ve got some exciting new ideas for your business – you are thinking of launching a new product, expanding into a new geographical region with your existing portfolio or perhaps you are a new business.
At many stages of its life, a business requires funds from external sources whether it is to set up a new venture, invest in research and development, acquiring additional resources to increase production or keep operations afloat during a financial crisis.
Your Business Needs Funds
Funding from external sources can provide much-needed support to companies in situations where they cannot cope on their own. With different types of funds available, it is often difficult to choose which one would be appropriate given the business’ current situation.
Choosing the wrong financing option can quickly get a business into a mess. When seeking funds, it’s essential to understand that it’s not just about money – there are terms and conditions attached that will have an impact on your financial well-being.
High-interest payments can significantly reduce profit margins while tight terms restrain the business’ ability to operate independently and have full control over its decisions.
To make the best use of external financing, here’s a list of 7 common mistakes to avoid.
1.Failure to Plan Ahead
If you wait until your business funds fail, you are only creating trouble for yourself. You can look for financing options when the business begins to suffer from a shortage of funds
Applying for a loan and getting it approved is a time-consuming process. While there are fast-processing short term loans available, they tend to be more expensive than other loans. After all, if you want the added benefit of quicker processing, you will have to pay extra for it.
The key to anticipating your fund requirements is to regularly review your financial situation and make forecasts so that any shortfalls can be identified ahead of time.
When embarking on a new business venture, regular forecasting is even more critical as the business steps into unknown territories and estimates can be less accurate.
2. Not Knowing How Much You Need
Getting more or fewer funds than you need can turn out to be a costly mistake. If you receive too much funding, you are just building up your business’ liabilities unnecessarily. It is also easier to overspend when you have extra funds. However, problems arise when you have to keep up with high-interest payments and repay them in the future. It often leads to discontinuation of some of the business’ operations.
While it’s important to be optimistic and think your business will do well in the future, underestimating your fund requirements means there’s a high chance you will face financial trouble again, soon after you have arranged funds. That’s because there weren’t enough to meet your requirements from the beginning.
How do you determine the amount of funds you need? Make a realistic budget, and while you allow some margin for contingent expenses, do not go overboard.
For a new business seeking funds, it is a good idea to have funds equal to your fixed costs for six months before starting. Estimate this figure and work from there.
3. Choosing the Wrong Type of Funding
There are many different types of finances available for modern business, and it is crucial to choose one that suits your needs:
- Equity
It involves giving investors a share in the company in return for the funds they provide. It can be in the form of money from friends/family, venture capitalists, angel investors, or the general public. In this case, there’s no interest involved or repayment, and you do not increase your liabilities. Since investors are owners, they have a say in how the business runs, and there’s a loss of control.
- Debt
With debt, the lenders have no ownership in the business, but there are periodic interest payments plus the principal amount that must be repaid within a defined period. Acquiring too much debt also weakens your financial position. There are various types of loans – short-term and long-term bank loans, lines of credit, invoice factoring, equipment loans, and leasing, among others.
The pros and cons of each option should be evaluated to determine the one that best suits your business.
4. Look for the Best Terms
Once you know the type of funding you require, you must search around to find the best deal. Your bank doesn’t always offer the best rates and terms – so you must weigh alternative options to find the best one
Especially if you are a well-established business with a good credit score, you should be able to find several lenders who are willing to provide funds for your business with favorable terms and attractive rates.
Some extra time spent analyzing all your options can help generate significant cost savings in the long term.
5.Having a Detailed Plan
Applying for a loan when you don’t have a clear idea of how you will use the funds significantly reduces your chances of getting it. Without a detailed plan, you cannot persuade people to invest in your business, whether it is equity investors or lenders.
A plan shows the commitment that the business has clear objectives and a strategy for achieving them, giving lenders the impression that their money is in good hands.
When applying for a loan, go in with all your paperwork – your financial statements and financial projections showing how the funds will be used and the returns it will generate, highlighting the fact that you will be able to repay the money in the future.
6. Understanding the Terms of the Agreement
When seeking funds, you don’t just need to pay interest and the principal amount of the loan. There is an initial fee for processing the loan as well as extra charges for late payment. The business can avail the advantage of the reduced amount if they pay earlier than the time defined in the agreement. All these terms should be considered before signing the financing agreement
It is also important to review other terms of the contract and make sure you understand them. If there’s anything you want to clarify, make sure you discuss it with a finance attorney or financial advisor and negotiate with the lending authority if there are any requested changes.
7.Keeping Personal Finances in Order
Many small business owners finance their business ventures by taking loans in their name using their credit cards or in the form of loans from family or friends. It is a risky approach because if the business fails, the individual is left with a debt that they must pay by themselves.
Even if the business isn’t doing well enough to make loan-related payments on time, it is the individual’s personal credit rating that is affected. So, it is best to separate the two and ensure that your personal finances stay in order.
The Bottom Line
Seeking funds for the business is indeed a daunting process. By avoiding the common mistakes in seeking loans for your business, you can reduce the risks attached. Make sure to do some planning before you acquire loans. Start by analyzing your current situation, evaluate different financing options, and seek help from a financial advisor if needed. With a little effort on your part, the additional money will grow your business, instead of tearing it down.
