Bank loans are one of the ways used to finance a business. If you have excellent credit, collateral and a solid business idea, bank loans can be easy to get and offers higher credit limit.
But bank loans are not for everyone. In fact, for some, getting a bank loan is the worst decision that they can make for their business. Successful entrepreneur and investor on the television series “Shark Tank” Mark Cuban said it best in an interview on Bloomberg:
“If you’re starting a business and you take out a loan, you’re a moron … there are so many uncertainties involved with starting a business yet the one certainty that you will have to have is paying back your loan. And the bank doesn’t care about your business … it’s just a complete conflict”
First and foremost, bank loans are not easy to get – especially for a small business (and even tougher for home-based businesses). Banks won’t easily give you a loan just because you think you have a great idea for a business. In the article Pros and Cons of Financing a Business , we listed some of the challenges of getting a bank loan, such as:
- Banks are very conservative lenders and will require you to personally guarantee the loan with assets that you might not have.
- Banks require collateral, and there is a risk of losing the collateral if you are unable to pay the loan. You risk losing your house, property, investment portfolio and other assets should the business fail to take off.
- Banks will also not give you a loan if you are in an industry they consider as “high risks” such as home-based businesses; or that you have not clearly demonstrated your experience and knowledge in operating such business.
However, Cuban raises the point that bank loans can a huge risk for a new business because you likely have no idea if your business is viable. If your business fails to make the kind of profits that you hope it will make, you’re still stuck with paying the loan. Your loan debt can be a huge drain in your cash flow making it even harder for your business to succeed. Instead of channeling what little money your business brings in to activities such as marketing or product development, you have no choice but to use your money into paying your bank loans. And when the bank starts calling you asking for the payment, that will definitely keep you awake at night and add to your stress levels.
The risk increases if you secured the loan with collateral and personal guarantee. You may not be looking at just the failure of your business, but the risk of losing your own house, assets and other collateral. You then risk facing personal financial collapse – even push you to bankruptcy — which will further hinder your ability to raise funds from other sources.
Starting your small business on borrowed money increases the risk of its failure. Unless you are absolutely 100% certain you have the next big thing or you have a proven business model such as starting a franchise or real estate development, avoid the banks. Instead, try using other sources of funds such as crowd sourcing or angel investors. Or you can borrow from sources where your risks are limited such as family and friends, or credit cards – and make sure that you thoroughly understand how paying off these loans could affect your cash flow.
Starting a business slowly on a small investment but no loan may be a more prudent course of action for a home-based business; rather than starting a bigger business but you are in debt up to your eyeballs.