One of the major sources of headaches most entrepreneurs experience is getting funds for their businesses. It could either be during the start-up stage or when there is a need for expansion. And at this point, getting a short term business loan will definitely look like a very wonderful option.
For instance, you may have used up all the space you have and you need to lease a bigger structure. There may be an advert for some equipment or machinery that you just can’t seem to stop thinking about, and you are convinced your business desperately needs it.
The only problem is that you don’t have enough money to do these things, and taking a short term business loan seems to be the most viable option.
I wrote this note to help you make the right decision. And this means helping you to see both the pros and the cons of what you are about to do. I wrote this to help you put things in the right perspective so as to make the right choice.
I understand what it feels like to be under pressure. I know what it is like to see something you really love, which you feel is the best thing your business needs but which you don’t have the money for. At that point, a short term business loan may seem like a heaven sent gift.
But is it?
That is why I wrote this. They are five reasons you should think twice before taking that short term business loan.
- You haven’t really exhausted all your money raising options.
One of the major issues aspiring entrepreneurs face has always been the problem of raising capital. It is a recurring decimal! I have personally lost count of the number of people I’ve met, who have wonderful start-up ideas but are stuck because “there is no capital”.
My answer to such situations has always been the same. “Capital is not the main issue” And the reason I say this is because so many people are just too lazy to build a start-up, and the excuse of not having capital is just what it is, an excuse. In many cases it is what many would-have-been-start-up CEOs tell themselves to justify the fact that they are too lazy to explore the options available to them.
Don’t be like those people. Dare to be different.
But let’s say you have already started, and you have successfully run your start-up for a couple of months or years. I will equally assume that you have grown your customer base and you need to expand. At this stage, the next logical thing for you to do is to take a quick short term business loan.
But before you do that, pause!
Taking a short term business loan is almost always a very tempting option because it promises to give you the funds you need quickly, and in one large sump. But there are other options you need to explore before you get that loan.
You can still ask your good old dad for some financial assistance or a loan without interest. And there could be some stuff you don’t need which you can pawn to raise extra money. Maybe you will have to go for another mortgage on your home or get a new credit card.
These options may not look too good, but they can come in handy when needed. Best of all, the interest rate won’t be as much as what you will get when you take short term loans.
Or how about convincing your clients to put some money down for that contract? I mean, it is possible that the reason you need the loan is to execute a contract. Why not use your client’s money instead? Who knows, the reason they have not given it to you may be because you have not asked.
2. Short Term Business Loans come with interest rates that are not usually as little as they seem.
Assuming you walk into the nearest short-term quick business loan office. You may be overjoyed at the prospect of getting a business loan at a 3% interest rate. But before you get carried away at such a wonderful prospect, do you know that these interest rates are usually on a per month basis?
Let’s assume you applied for a quick loan of $100, 000 for one month, and you are supposed to pay $103, 000 at the end of the month. But let’s say that due to some unforeseeable circumstances, you couldn’t meet up with the payment, and you unfortunately need to extend the loan for another month.
This means you will still need to pay an additional $3, 000. If it lasts for a year, you will end up paying $36, 000. In other words, the interest rate is not really 3% but 36%, and that doesn’t sound so wonderful anymore, right?.
This was exactly what happened to a very dear friend of mine Sammy.
Sammy had a wonderful business idea and he just couldn’t wait to run with it. Unfortunately for him, and just like many people will do, he went for a short term business loan.
In his case, everything was supposed to work out just fine. I mean, he had done his feasibility studies, and the business looked promising.
He planned to print customized tee shirts for an organization where he played a very active role in. He met a couple of people around who assured him that getting a customized set of tee shirts was in fact the best thing that could happen to them, apart from sliced bread.
With as much enthusiasm he could get, Sammy took a short term business loan from a loan shark. It was a $600 loan with a 10% interest. (For a short term business loan, this was a killer)
Sammy was supposed to sell off the tee shirts in a few days, get back $600, and pay an additional $60 to the loan shark from the profit he was supposed to make. It made perfect sense since he was expecting a profit of about $200 from the deal.
However, he did not put into consideration that there is usually that annoying thing called ‘unforeseen circumstance’. And just when he was not expecting it, the unexpected happened.
Sammy produced 150 customized tee shirts but was not able to sell more than 15. And that number was sold out of personal recognition. It was really devastating because he didn’t just lose his capital, but equally had an interest to pay off.
Just like most people who don’t understand how short term business loans work, Sammy decided to do everything within his power to raise the money in a space of about 6 months. His plan was to pay in $100 every month till the debt clears.
Wonderful plan, right? I mean, it was logical.
Six months later, my dear friend went to the loan shark with the last part of the payment, $100. He had the mind-set that the only thing remaining was to settle the issue of the interest, which was just $60.
What he heard was a very different story. It was only then that the loan shark explained to him that the 10% interest rate was a monthly thing. And since seven months had gone by altogether, my friend suddenly saw himself indebted to the tune of $420.
Sammy’s story is pathetic because he didn’t have a job and his last shot at starting a business didn’t exactly work out fine. So his income was mainly gifts and favours from family and friends. Because of that it was very difficult for him to pay off the debt.
Guess what? 10 months later, he was still in debt, to the tune of $220. And that was because he was only able to raise $800 in those 12 months. (Remember he had no income source, and each month meant an additional $60. That’s why they are called loan sharks).
His ordeal would have continued if not that he went to a friend for help. And he was able to borrow the remaining money from this friend and pay off the loan shark. At least his friend gave him the money at a 0% interest rate, so he was totally safe.
Don’t let that happen to you.
3. Your expected profit may not be enough to cover the interest rate.
Let’s assume you get a contract worth $400, 000 to execute a project, and you need to take a short term loan of $100, 000. If your expected net profit at the end is about $100, 000, and the interest rate is 3%, then you should take the loan because the profit can easily take care of it. I mean, with a 3% interest rate, the interest is $12, 000.
If on the other hand, your expected profit is less than the interest you are supposed to pay at the end of the deal, then you should really think twice about the loan.
For instance, if the expected profit from your business deal is $1000 and your short term business loan interest is $1050, why bother?
NB: No matter how good the profit seems however, make sure you perform a revenue forecast and take your decision based on factual numbers and not just your instincts.
4. You can leverage on your long term business relationships.
One of the major advantages of building strong business networks and maintaining good business relationships over time is for times like this when you are in a financial crunch and need help.
At a point in time for example, I convinced one of my top customers to make a huge deposit for a supply a few days before I supplied them. Due to the level of trust in our business relationship, she did. And rather than take a loan to make that supply, I ended up using her money.
In the same way, you can get your business partners to make supplies to you on credit rather than taking a loan to make a supply. This however, will be possible only if you have proven yourself to be credit worthy in the past.
5. You may not really need that loan.
Before you take that leap and grab that loan, it is very necessary that you ask yourself if your business really needs the loan.
Is the equipment you want to buy really necessary or is it something you want to get just because it looks shiny? Is the installation of new air-conditioners and cable TV, and office revamp really that urgent? Is it something you really need or can it wait? The new staff you want to employ, do you really need them, or can your business do without them for a bit longer?
Have you ever fallen into the hands of short term business loan sharks? Please share your experience in the comment section. Do you agree with the points made here? Do you have other reasons why start-ups should not go for short term business loans? Please share your wisdom with the MSC community.
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