Business loans are an excellent tool for funding your vision and investments. Acquiring funding provides the growth needed to move past the initial startup phase. For investments and businesses, it's essential to understand how you’re getting into the loan and how you’re exiting. For instance, if you’re buying a property for investment purposes, it's essential to know all of your numbers and how you are exiting, whether that be through a 1031 exchange or cash out. Although, even if you’re intricate in planning and have your margins down to a tee, it's still crucial to understand the risks involved with these loans.
When taking out a business loan, the owner(s) may have to use their credit to guarantee the loan. Small and new businesses would face this problem more often since they’ve not established a profitable history or a record of repaying money that has been borrowed. This means the owner(s) will have to use their social security number and sign documents that state if the business doesn’t repay the loan, the individual(s) who own the company will do so.
Why is this a risk? Because if the business has any problems with repaying the loan, it will show on the owner(s) personal credit history. This could create personal issues for the owner(s) if they needed a loan in future. For owners who have faced problems getting a loan due to credit, they may want to try one of the best debt consolidation loans.
Loss of assets
Sometimes a business loan will be granted if the company has proper collateral. Collateral is usually in the form of assets that are used to secure the loan. Some assets that a business would use include but aren’t limited to:
- Real estate
- Account receivables
Why is this a risk? Because the loan company or bank would take ownership of these assets if the loan isn’t repaid according to the terms. The business equipment could be essential instruments in creating the cash flow they need to repay the loan. If that equipment is confiscated, it would be hard for them to function, and they may eventually go bust. The same goes for land and real estate. Since account receivables are revenues that the company has earned but not yet received, this could be a big issue for them because they would no longer be entitled to this revenue.
Interest rate fluctuation
Depending on the type of business loan, the company will have to pay back the principal of the loan as well as interest. This is typical; however, the interest repaid depends on the type of loan. A fixed-rate loan means that the company would repay a set amount in interest over the term of the loan. This is probably the best option because when you know what your payments will be monthly, it helps with budgeting. A variable rate loan has an interest rate that can change during the term of the loan. This is a risk as it can lead to higher payments, which in turn can cause repayment issues.
Defaulting on a loan is simply the act of not repaying it or being late with the payments. Either way, it's not a good sign if a business is struggling to repay the monthly payments of a loan. If it isn’t repaid, it would be challenging to obtain new loans or services because of higher interest rates, lower loan amounts, and other issues. A defaulted loan follows the company and its owners negatively until it’s cleared up.
Too much debt
Sometimes a business will realize that they can obtain multiple loans either at the same time or overtime. But just because a business can do so doesn’t mean they should. Why is this a risk? If loans are repaid and new ones are obtained, then the risks are minimized. This would help the company establish a great history of repayment. However, if they obtain a loan and borrow more before the first loan is repaid, it may be a sign that the business is having serious money problems.
When a company regularly borrows money, it raises the question of whether they’re making a profit. If the company isn’t, then it’s only a matter of time before they declare bankruptcy and go out of business. This would also raise a question about the money management skills of the owners and managers.
Why? When a business borrows, it’s usually used to make more money. But if they keep borrowing, it may show that those in charge don’t know how to make money or have made some bad decisions that have cost them.