What are the advantages and disadvantages of getting a business loan?

If you wish to build and nurture your business, it is absolutely essential that you have the financial resources to be able to do so.  A lot of the costs associated with scaling up a business will only provide long-term returns and you cannot therefore count on the immediate increase in sales to provide you with the necessary positive cash flow.  If you rely entirely on your own resources (as many conservative Chinese businesses in Singapore do), you run the risk of being stretched in business downturns and possibly defaulting on your commitments or going bust.  It is also possible that the limitations on your personal resources could prevent you from achieving the full potential of your business.  It is therefore reasonable to balance your own resources with debt which will normally be available in the form of a loan.  Leverage within reasonable limits is an excellent way of multiplying your business prospects.

Here are some of the advantages of getting a business loan:

  • Your ownership is retained and you do not have to sell shares in your business to another investor.  The lender is only entitled to an interest payment on his loan and not part ownership or a share in the profits of your business.  Moreover, you will not have the interference in the management and the running of your business which another investor might demand.
  • It gives you a great deal of financial flexibility because there are often no restrictions on the use of the money from the loan.  You can either invest in business operation in the form of increased current assets such as receivables and inventory or you could even use the money to pay off current high cost debt.
  • You can make optimum use of your cash flow because loan (e.g. personal loan) payments can be tailored to suit your cash inflows and outflows.  You can thus conserve your working capital while making the maximum use of it
  • You can refinance your present fixed assets such as buildings and mass release cash that can be used for more productive business purposes.
  • You will derive considerable tax advantages because interest payments are deductible as expenses in computing your pre-tax profit.  On the other hand, equity must be serviced from after-tax profits and is not a deductible expense.

Here are some of the disadvantages associated with a business loan:

  • You or your partners may be required to provide additional guarantees to the bank depending on your credit standing.  This could affect the personal credit rating of your partners or yourself and affect your personal standing with the lender.
  • The lender may require additional collateral in the form of your property or other personal assets.  If you default on your loan, the lender is free to sell the collateral that you have provided to repay the loan.  Try and limit the collateral to as reasonable an amount as possible and ensure that the lender releases his interest when the loan has been repaid so that this threat no longer hangs over your head.
  • The lender will normally specify what events constitute a default under the loan agreement.  Make sure that you understand these events and that they are not unreasonable or arbitrary in which case you should have them deleted from the loan agreement.

Leave a Reply

Your email address will not be published. Required fields are marked *