Let’s start with an appreciation for debt: “All debts are equal, but some debts are more equal than others.” (My apologies to George Orwell for adapting his famous quote!)
At some point in our life we may need debt or require debt to achieve our goals. Our aim should be to get as much of that debt as “good debt” which is more equal than “Bad debt”!
Good debt has the potential and aim to increase wealth or enhance your life. Bad debt is borrowed money to purchase goods or services that depreciate in value or where the benefit received by the goods or services is gone once consumed. Bad debt is also not tax deductible and so the interest costs keep hurting until the debt is paid out in full.
Small business loans are no different. They can be good debt, or become bad debt if not managed well.
So let’s look at what a small business loan is to better explain our top ten tips to maximise the use of it.
How Do You Fund a Business and What Are Small Business Loans?
The following are examples of ways to fund your business plans:
- If you are expanding you could use accumulated profits from your current business activities which can take time to accumulate,
- Find an investor,
- Research and apply for a business grant,
- Personal savings
- Use Equity or debt Crowd Source Funding (CSF)
- Use a small business loan for growth, which is one of the most common methods for financing a new or existing business.
Small business loans are specifically used to start or expand a business. These are agreements made between a business owner and a lender, such as a bank or a finance company. All small business loans require the borrower to make capital repayments on the amount borrowed, as well as paying interest. Small business loans have a higher interest rate than residential home loans, however one of the major benefits is that you do not reduce your ownership in your business using a small business loan and all future profits go back to you.
Our Top 10 Tips to Maximise Your Small Business Loan
Ensure you have a business plan that specifically covers the use of the debt funds
Without a well-thought out plan, you will not have done enough preparation on knowing the revenue targets you must achieve to reach your goals or the expected costs and cash flow position you will likely be in. It is important to know that a Business Plan is not a perfect finished document that predicts everything. It forces you to consider many elements that you may not have considered and therefore capture more opportunities and manage as many risks as possible. By doing this, you will have a more accurate estimate of how much you need and when you will need it.
Lenders will nearly always want to see that there is a plan and that you are aware of the cash flow constraints and the time of those constraints. It is very disruptive if you need to go back to your sources of funds and ask for more money only months after you raised money because you did not consider enough factors.
By always seeking to gain more from the use of a small business loan than just growth or starting a business and getting immediate sales, we gain more long term value from the use of those funds. This is the best outcome that can be realised from a thorough business plan.
So: Plan… Plan… Plan.
Get the most competitive business loan terms you can by collecting at least three different proposals by banks and finance companies.
It is a lengthy process of providing information to lenders to assess their loan offering, however they will mostly ask for the same information so you may as well take the opportunity to shop around and get the best small business loan deal by seeing at least three lenders.
Use a small business loan to improve your buying power
Businesses that are expanding or those that are getting started can utilise the small business loan to increase their buying power. This means they can buy more products or raw materials and achieve better prices due to the volume. This is something that must be analysed carefully and would be part of the Business Plan process. Making sure you can buy more at a cheaper price also means you need to be able to sell the product quicker so that your funds are not tied up in stock that sells too slowly.
Use a Business Loan to reduce the cost of producing a product or providing a service
Using your small business loan to buy more effective machinery or improving processes or equipment will not only let you expand in producing more products but also in reducing the cost of production by reducing the labour costs involved in making that product.
This can also apply to service-based businesses where the adoption of new software or hardware can improve the efficiency of your labour and reduce the overall cost of providing that service.
The effect on both product based or service based businesses is increased profits and reduced labour costs and stress. New equipment and processes can also reduce health and safety risks for staff so an additional long-term benefit to the business and its people.
Use your business loan to increase brand awareness and market coverage
Improving your brand awareness through advertising has both short term benefits of increased sales but also longer term benefits of trust and recognition in your brand, product or service. As Henry Ford has said:
“Stopping advertising to save money is like stopping your watch to save time.”
This can be done by hiring more staff focused on sharing the benefits of the brand and/or using effective software and systems to tell people how you can help them solve their problem.
One of the best ways to increase market coverage is to develop or improve on the effectiveness of your website. Making it mobile friendly and up to date is essential in getting in front of your customers and making it easier to solve their problems. This is the most effective way to increase your access to a much larger market and using experts to assist you in this will provide a greater return on your funds. As Jeff Bazos, Founder of Amazon has stated very simply:
“It’s hard to find things that won’t sell online.”
Use your small business loan to enhance your staff’s ability to offer better service
Investing in your staff by providing more training and improving their skills will not only result in better products and or services being delivered, but will also make your staff feel empowered, respected and cared for. Other benefits include making the workplace safer, having more engaged and motivated staff and better staff retention.
Stick to your plan and put procedures in place to ensure the funds are used as planned
Keeping the business loan funds in a separate account is a good way of putting in place procedures to assist you in being disciplined about the use of those funds. This creates another step to get the funds out of this account and into your everyday transaction account.
Make sure you use your funds in a controlled and timely manner
Try not to spend all the funds at the same time with all the different intended uses. This will ensure you are able to focus on one project at a time and not have too many projects going simultaneously which can result in you not paying the right amount of attention that is needed to make it a success. For example, beginning a new marketing program while implementing new equipment and production processes and hiring more staff that need to be trained may mean you do not give each element the necessary attention.
Maintain good communication with your lender
Keeping regular communication, especially in the first years with your lender and making sure that repayments are on time and sometimes a little early is a great way to maintain a healthy relationship. You never know if you will need to borrow more in the future for more expansion projects or you may need to delay payments temporarily. A good relationship improves your chances of getting the best outcome.
Make sure that you structure the business loan effectively
I have left the best for last, in my opinion. Whenever you are using loan funds, always make sure they are structured to increase the tax effectiveness of your group or family’s loan position.
Let’s look at an example:
You have a mortgage on your home of $300,000. You also have cash savings of $300,000 and you need $600,000 to start or expand your business.
The most effective use of your funds will generally be to apply the cash of $300,000 against your home mortgage and borrow $600,000 for the business rather than using your cash savings of $300,000 and only borrowing $300,000 for the business. There are some factors such as interest rate differences between the home loan mortgage and a small business loan however by making the full loan “good debt” you can not only use the funds to increase wealth or enhance your life, but the interest is also tax deductible and can reduce your tax burden.
Where to from Here?
As I hope you can see from these tips, it is imperative that you spend time planning and seeking advice from those around you and or professional advice to make sure you not only set things up properly to start with but also you can maximise your return and have more fun doing it.
Please reach out to us at Bishop Collins if you would like to seek professional advice on how to apply for a small business loan.