If you're starting a new business, you have to take a lot of things into account. One of the biggest ones is how you're going to raise money to start your new business.
While you might have some money stashed away, odds are you'll have to borrow money. Most commonly, you'll probably have to take out a business loan.
While taking out a business loan will give you the funds you need to start your business, it carries some risk. Here are five reasons why taking a loan can be risky for a new business.
Not reading loan agreement
When you take out a loan, you’ll most likely have to sign a loan agreement. This is a legally enforceable document that bounds two or more parties establishing the terms and conditions for the amount of money being borrowed and how it will be repaid. It's easy to sign a loan agreement, but you can face serious financial troubles in the future if you don't read the contents carefully.
One of the biggest things overlooked is the amount of interest you're being charged. When you borrow money, you generally must pay an interest rate that adds more debt to the money you owe. Many people don't realize this right away and can't keep up with their payments. Failing to make consistent payments can result in added late fees, increasing your debt.
When you’re taking out a loan as a new business, you generally do not have an established history of being able to pay back your debt. What generally happens next is you, not your company, have to take liability if your business cannot repay its loan.
This is an issue because you run the risk of ruining your credit, which is important for many things, including housing, jobs, and loans for a different purpose in the future.
As a new business, you might have to offer some collateral to secure the amount of money you need. Some common types of assets used as collateral include land, real estate, or expensive equipment.
If you can’t repay your loan, lenders have the right to seize the assets you used as collateral. This can be bad if you need these assets to run your business or if they were personal.
Too much debt
If you quickly run out of money, can’t quite pay it back, and have to take out more loans, you accumulate too much debt.
Too much debt is an issue for several reasons. For starters, it's a sign to lenders you're not good at managing your money. Second, it also shows lenders your new business is having trouble making a profit. Finally, more debt will only worsen your money issues. It doesn't solve problems more than it creates them.
In a more worst-case scenario, if you take on a loan you can’t repay, your business fails, and you lose all your assets due to putting them up as collateral, you will probably be financially ruined.
While you can file for bankruptcy, you will have lost a lot and practically have to start over. Of course, this is one of the risks of starting and running a business.
Loans can be a tricky thing to navigate. They take careful planning and awareness on the business owner’s part.
Taking out a loan is a necessity for many new businesses, though. You shouldn’t necessarily be afraid to take out a loan, but you should know the risks.