5 Common Business Loan Mistakes (and How to Avoid Them)

There are many small business loan mistakes that could leave you unable to obtain the financing you need, getting hit with high interest costs, or taking on too much debt. We know that small businesses are vital to our economy, so we put together these business loan application tips and a list of common business borrowing mistakes so you can understand how to prepare for a business loan, the paperwork you’ll need, and what lenders expect in an application.

Why Business Loan Preparation Matters

If you met with a prospective employee or a vendor and they weren’t prepared, didn’t know anything about your business, and couldn’t answer your questions, you probably wouldn’t hire or do business with them. Before hiring someone or signing a contract with a vendor, you probably do your homework and figure out what you need from them, so you know what you’re looking for and can make the right decision.

The same is true with a business loan. Taking a close look at your business financials, your assets, figuring out what you need, and considering all your options are crucial for any financial decision. You’ll also need to make sure you have all the right paperwork that’s 100% accurate and explains what your business is about and what you need. Lenders will want to get a clear picture of what your business does, your need for funds, and how you’ll use the loan to grow your business.

The Cost of Applying Before You’re Ready

Applying for a business loan before you’re ready could result in being rejected by lenders or winding up with terms less favorable than if you’d been better prepared. Taking on debt without a clear plan of how to best use the funds could lead to an inefficient use of resources. Unfavorable loan terms could result in a cash crunch, making it hard for your business to cover its bills and loan repayments at the same time.

Mistake #1: Not Knowing Exactly Why You Need the Loan

Any lender will want you to have a clear reason why your business needs a loan and how you’ll use the funds. Borrowing funds just to keep your business operating isn’t enough. Do you need to hire more people? Buy equipment or inventories? Relocate your business? Lenders will want to see that you thought this through and have clear, realistic plans for using a loan and increasing your profits.

How to Match a Loan to Your Business Goals

You have different types of business loans to choose from, which is another reason why you’ll need a specific reason in mind when you apply. Here are a few of the most common small business loans:

• Term Loans: A conventional business loan, issued by a bank, that could be used for buying equipment and other major purchases or investments. The loan is typically paid back through fixed monthly payments, which offer predictability that you can budget for.
• A Business Line of Credit: A pool of funds that you can draw on as needed and only pay interest on what you withdraw. When you pay back the funds, you can draw again. These are often used for covering unexpected expenses or managing cash flow when your business income is cyclical in nature.
• Small Business Administration (SBA) loans: Issued by local banks and backed by the federal government. These offer low down payments and low interest rates. They’re often used by businesses that have a hard time qualifying for traditional business loans.
• Equipment loans: Used for buying equipment, with whatever you’re buying serving as collateral. This lets your business buy what it needs to increase or maintain production while also preserving your cash flow for other uses.
• Commercial Real Estate Loans: These are used for buying commercial properties, real estate, and building or improving a commercial space. When used as a construction loan, the proceeds are issued in installments as each phase of construction is completed. You would make interest-only payments during the construction phase. When construction is complete, the loan would convert to a commercial mortgage, and you would start to pay back the loan.

Mistake #2: Bringing Incomplete Financial Documents

Meeting with a loan officer without all the necessary documents would make them think you weren’t ready for a business loan. They might question whether you would be successful and consider you a credit risk. That’s why it’s crucial to make sure you have everything you need to apply for a loan. Having all your records organized and up-to-date can help you make the right decision and can make a good impression on a loan officer. Having good cash flow records is especially important. A lender must be aware of your income, expenses, and seasonal cash flow issues, which can help determine how much you could borrow and the payments you could afford.

What Lenders Usually Want to Review

Lenders will want to see evidence that explains what your business does, your plan for success, and your financial information. This includes:

• Your business and personal income tax returns for the past two to three years.
• Profit and loss (P & L) statements.
• Balance sheets.
• Cash flow statements.
• Bank statements for the past three to six months.
• Any business licenses, professional licenses, and registrations that you’re required to have.
• A business plan that explains your operations, your growth strategy, and how you’ll use the loan. You may need to update this to make sure it’s current, such as your financial projections for the next one to two years.
• Credit reports for yourself and your business. Lenders will check this information anyway and giving it to them upfront can make a good impression.
• A list of any business debts and your repayment schedule.
• A list of your personal assets and liabilities (debts). This is especially important if your business is relatively new and hasn’t established much of a credit history.

Mistake #3: Ignoring Credit and Cash Flow Issues

You can pull your credit reports from AnnualCreditReport.com or from each of the nation’s three credit reporting bureaus: Equifax, Experian, and TransUnion. Make sure there aren’t any mistakes, such as accounts or loans you don’t recognize. If there’s anything that’s hurting your credit score, see if you can address this before you apply for a loan. This might involve reducing your personal debts and clearing up any delinquencies.

If any of your reports show a bill that went to a collections agency, and you paid it off, you might ask them to remove it. You should also check your business’s credit report from agencies like Dun & Bradstreet. Try to avoid taking on new debts or credit accounts, for yourself or your business, if you’re getting ready to apply for a business loan. This could negatively affect your credit score and raise questions about why you need a loan.

Why Repayment Ability Matters

Lenders will want to see that you have a plan for paying back your business loan, and the ability to do so even if your financial projections aren’t as profitable as you expected. This is why lenders will want to see a list of assets for both you and your business. A lender might also ask for a personal guarantee that you’ll be responsible for paying back the loan out of your own pockets if your business can’t afford to do so.

Lenders will be more likely to grant a loan with this kind of guarantee, because it reduces their level of risk while also indicating that you believe in your business and are willing to back that commitment with your own assets. Remember that if you’re unable to pay back the loan, your personal assets could be at risk. This might include your home, your vehicles, and any savings or investment accounts you have.

Mistake #4: Borrowing Too Much or Too Little

When applying for a business loan, it may be tempting to ask for as much as possible, especially if you secure a favorable interest rate. Unfortunately, this could also create a temptation to borrow and spend more than you need to. Paying back the loan could also give you cash flow issues. Of course, not borrowing enough might leave you with a different kind of funding shortfall. Even if you did obtain a second loan later on, it would likely have a higher interest rate.

How To Right-Size Your Financing Request

Making sure you borrow just the right amount can be difficult. Here are some things to consider:

• Why you need the loan and how you’ll use the funds. This can help you narrow down the cost of your plans.
• Your cash flow projections, profit and losses for the next two to three years.
• What your loan repayments will be like and how this will impact your cash flow.
• Figure out your earnings before interest, taxes, depreciation, and amortization (EBITDA). A general rule of thumb is to keep your total debt at less than three times this figure.
• What’s the potential return on your loan? Does the increase in profitability justify the cost of borrowing?
• Estimate the cost of not borrowing. What would happen to your business if you didn’t borrow the money?

Mistake #5: Waiting Too Long to Talk to a Lender

While you need to be fully prepared when you apply for a business loan, there’s also a risk of waiting too long before consulting with a lender. This could leave you unable to secure a loan for when you really need it or borrowing funds at a higher interest rate (such as a credit card). Many retail stores make most of their profits over the winter holidays. Businesses that are involved in hospitality and tourism also see ebbs and flows in demand. If your business will need a loan to hire more staff and stock up inventories before a seasonal rush, any delay in securing a loan could make it difficult for you to make that kind of investment.

If you know you’ll experience a cash crunch at certain times of the year, obtaining the credit you need ahead of time can give you the financial security you need to stay in business. It can also help you pursue new business opportunities. Imagine securing a major contract and having to scramble for the funds you need to fulfill that order. Having the right amount of capital could help you meet that demand, while failing to deliver could cost your business in terms of revenue and reputation. Having the funds you need to buy in bulk could also earn you a discount when purchasing inventories.

Why Early Conversations Can Save Time

Even if you already have a relationship with a banker, talking with a lending official before you apply for a business loan can give them the time to understand what your business does and what your needs are. They can explain what your options are for a business loan, provide a detailed explanation of the kind of documents they’ll need, what to expect during the application process, and give you an idea of how long it can take to secure a loan. A banker can also help you spot any issues that could impair your application and give you time to address them before you apply.

How Flanagan State Bank Can Help

We’re a neighborhood community bank, and we make our lending decisions locally, with a lending team that understands the local business climate and wants to help small business owners succeed. If you’re considering whether you need a small business loan and how it works, we’re here to help.

Talk With a Local Business Lender Before You Apply

Every business loan starts with a conversation with a local business owner and someone on our Commercial Lending Team. If you have any questions about business financing and loans, please reach out to someone on our team or contact your local branch to start a conversation.

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