If you are looking to buy a business or franchise, financing is nearly as important as the business you buy. The right capitalization strategy can improve a small business or franchise’s ability to grow. The wrong capitalization strategy can leave the business starved for cash (from debt payments) or unable to reach profitability before the available cash and credit is consumed.
Over the past 6 years we have worked with thousands of aspiring entrepreneurs and small business or franchise owners to invest in a business. They have taken different roads to small business financing. Some of those clients have invested their retirement funds in their new business without getting a loan or taking a distribution. Others have used unsecured or SBA loans or a combination of many. Through that experience, we have seen many new entrepreneurs make mistakes along the way, and we have correspondingly developed the following information to improve your ability to obtain a loan as you prepare to buy or build a business.
Top 5 Small Business Financing Mistakes
The following are the five most common financing mistakes that entrepreneurs and small business owners make:
- They make big purchases. Buying a car, a home, a boat or other big purchases can create inquires on your credit report (if you obtain new sources of credit) or negatively impact your debt-to-income or credit utilization ration if you pay for it using a source of credit. Each can have a negative impact on your credit score and affect your ability to obtain debt.
- They apply for business loans online. Many people begin researching small business financing over the internet, which is full of compelling marketing—all focused on getting you to apply online. Unfortunately, small business financing is often more complicated than the “one-size-fits-all” solution often found on the web. Most brokers or lenders will run your credit when they receive an online application. If you apply in multiple places, you will likely have an inquiry from each. The more inquiries you have in the last 6 months, the more it will negatively impact your credit score.
- They do not correct inaccuracies on their credit report. Many people are unaware that their credit report includes inaccurate information that is impacting their credit score. These surprises can significantly delay the financing process, as it can take time to remove these inaccurate items that may be affecting your credit score negatively.
- They do not take the time to understand their financing options. Many entrepreneurs rush to find small business financing, and this haste can result in the new business owner inadequately financing the business. Additionally, the sequence in which you deploy certain financing methods can have a significant impact on your ability to find the appropriate financing. For example, if a $25,000 unsecured loan is obtained, it may be reported as a credit a line for $25,000 that is carrying a $25,000 balance. That most certainly will drive your credit rating down and inhibit the ability to obtain additional debt financing going forward.
They do not have their current financial records organized. When you apply for a small business loan, most lenders will require two years tax returns, your last 2 pay stubs, bank statements, personal financial statement and supporting documentation. Not having these records organized can delay the process and/or jeopardize the loan.
Ensure You Don’t Make These Same Mistakes!
Here are five things you can do now to make sure that small business financing is simple, fast and affordable to secure:
- Do not make any major purchases (i.e., cars, homes, jewelry) until after you have purchased your small business if at all possible. Large purchases could make it more challenging to get approved for small business financing.
- Do not apply for any loans or credit lines without taking view of the complete financing needs of the business. Credit inquiries can impact your credit score even if you don’t get a loan. You may benefit from working with a consultant that specializes in small business financing.
- Obtain and review a copy of your credit report from resource sites such as www.freecreditreport.com or www.creditexpert.com. If you find any negative inaccuracies, such as late payments or outstanding judgments, get them corrected immediately.
- Work with a consultant knowledgeable in the wide range of financing/investment options to truly understand your financing options and their potential impact on the business going forward.
- Start gathering your personal financial information now so when you apply for a loan it is easier and faster to access the capital you need. Make sure you collect your last three years’ personal tax returns, three months’ bank and asset statements and so on.
These simple steps can help a lender understand what your future small business financing options are. Once you have reviewed your credit and have your financial records organized you will be ready to get prequalified by a financing consultant.
Securing small business financing is somewhat like looking for a new home. Real estate professionals suggest you get prequalified by a mortgage lender before you start looking at homes. Why? Because there is no point in looking at $500,000 properties if all you can afford is $200,000. The same rules apply in small business and franchise financing. It is a best practice to understand your financing options prior to pursuing a loan and before entering into any agreement or transaction.