It can be a wonderful feeling to be starting your very own business, however, very soon you can be left wondering as to how you will manage to raise the funds necessary for the purchase of equipment and raw materials, employee salaries, marketing expenses and the myriad of other costs that need to be incurred.
Your personal savings and contributions from family and friends may carry you through the inception stage, it is very unlikely that you will be able to sustain it for a very long time, and you will need to consider raising money from external commercial lenders like financial institutions such as banks. However, before rushing to sign on the dotted line you need to consider some essential aspects of borrowing money commercially.
The First Option for Funds – The Bank
If you are an entrepreneur, usually the first source of funds that you will consider, if you are thinking of borrowing money on a commercial basis is from banks. In the past banks have not tended to be very approachable for small businesses and made it quite difficult for small business to apply successfully for a loan with their stiff terms and conditions, and compliance.
More loan applications to banks usually tended to get rejected than passed. However, slowly but surely, banks have woken up to the immense potential of the SME sector and are now adopting a far friendlier stance to small businesses with special funding programs. However, entrepreneurs should appreciate that banks represent just one of the many options available for raising funds, and like any other funding source, they have their own pros and cons.
Why Small Businesses Find It Worthwhile to Approach Banks for Loans
Accessible and Convenient
One of the principal reasons why banks usually represent the first source of funding for small businesses is because they are conveniently located and very accessible. After all, most entrepreneurs have been using the same banks for operating their savings accounts and the bank personnel are known to them.
Banks are also favored because they can offer a very large selection of loans with different terms and conditions for consideration by the entrepreneur. Since the loan officers of the banks are usually quite experienced, they can be a source of invaluable help to entrepreneurs to choose the best loan.
The rate of interest charged on loans for the SME sector is relatively lower when compared to other types of institutional loans, and especially credit cards that charge a very high rate. The interest rate is lower because typically the bank loans are secured against the assets of the business, which makes loans safer for them. However, if your business is of the type where there are fewer requirements for physical assets, it is possible to get bank loans without collateral and spare yourself of the constant worry that you are putting the assets at risk in case your business does not do well.
When the loans are unsecured, the bank will not lay claim to them in case you are not able to pay back the loan due to a business downturn. Also, small business owners should know that it is possible to claim tax rebates on loans because they can set off the loan repayment from their profits.
No Need to Share Business Profits
There are many options where as an entrepreneur it will be possible for you to raise funds from angel investors or venture capitalists if they find your business idea and model to be attractive. However, typically, they will only give you the money in exchange for part ownership of the business venture.
This means that when your business is successful, you will find that a substantial part of your profits will have to be given away to the funders. You can also expect the venture capitalists to try and influence the way you run your business and make your decisions, which is never the case when you take a loan from the bank.
Once the bank has satisfied itself that the business has the potential to be successful and that you have the right credentials then apart from tracking the loan repayments, the bank neither takes a portion of the profits nor interferes with the management of the business.
Helps Build a Good Financial Reputation
Taking a business loan from a bank and ensuring that you pay it back on schedule can help you to build a credit profile that will, in turn, assist you to get access to larger sums in the future.
Reasons Why It May Be Better To Avoid Banks
Usually, commercial banks are extremely circumspect about extending loans to startups because more often than not the owners have no prior experience of running a business venture. This is the reason why a majority of startups go belly-up very soon after coming into existence. Banks, therefore, go through a complete process of examining the business potential, which can be extremely cumbersome for entrepreneurs. Personal credibility and credit rating are also very important factors that banks will take into account for considering the loan application.
The rate of interest applicable on a bank loan is determined by the market conditions as well as the government policies. These are liable to change at any point in time without notice, and it may be quite difficult for small businesses to accommodate interest rate hikes to the already-steep interest rates applicable on SME loans.
Requirement of Collateral
Usually, banks will extend loans for both capital expenditure and revenue expenses only if the loan amount is backed by physical assets or financial securities. Essentially this means that your ability to take the loan depends on the value of the collateral that you can provide, and more importantly, if the business goes bust, the bank will be entitled to sell off the security items.
As an entrepreneur who is keen on expanding your business, you will need to borrow funds from external agencies sooner or later. Though banks are the obvious choice, you need to take into account the various aspects that make the loan attractive or unappealing before coming to a decision.