Lately, I have found myself thinking about my first business. My first business collapsed in its infancy. That was about ten years ago. I wonder how things would have been, had the business survived. Looking back (and with the wisdom of hindsight), it is easy to see why the business failed. I now realize that the business mainly failed because I made financing mistakes. The business concept was good. The business plan was good. I had a good business location. I had good workers and good equipment. But the business failed because I made financing mistakes. I am not talking about ‘financial mistakes’ (which are broader). I am specifically talking about ‘financing mistakes’.
Ten years down the line, and I now think that I am wiser. I have established other businesses, with varying degrees of success. I have also seen other people establish businesses. Some have succeeded. Some have failed. Among the ones that have failed, a good number had one thing in common. They failed because, like me, the owners made financing mistakes. Financing mistakes are a major cause of business failure. If people were able to avoid financing mistakes, more businesses would survive. More businesses would thrive.
That is why I decided to focus on the topic of small business financing mistakes in today’s article. I will be trying to point out some of the small business financing mistakes. Those are mistakes that ought to be avoided by small business owners. And without any further ado, I will now go ahead to outline the small business financing mistakes in question.
Over-borrowing simply means borrowing too much. It can cause major problems later, when repayment time comes. This is how businesses end up going bankrupt. By the time we start talking about bankruptcy, your credit rating would have taken a severe beating. By that time, the assets you used to secure the loans may have been seized and sold…
In simple terms, if you borrow more money than your business is able to repay, you will have a crisis. You therefore shouldn’t borrow just because you have the opportunity to do so. Before taking a small business loan, you need to ask yourself two questions. Firstly, you need to ask yourself whether your business really needs the money. Secondly, you need to ask yourself whether your business really has the capacity to repay the money. In answering the latter question, you need to look at the worst case scenario. You need to be sure that, even in the worst case scenario, your business would still be able to repay the money.
2. Over-reliance on bootstrapping strategies
One business financing option is that of bootstrapping. This entails using your own resources to finance the business. It makes sense, up to a point. By opting to bootstrap, you avoid the entanglements that come with external financing. However, if you over-rely on bootstrapping, it can stunt your business’ growth. It can make it impossible for you to take advantage of opportunities that are open to you.
There is one obvious problem with the bootstrapping strategy. As we observed, it entails relying on your own resources to finance your business. Unfortunately, your resources are likely to be very limited. Thus, if you predicate your business’ growth entirely on your own resources, the growth will be slow. The growth you’d have achieved in one year using a loan may take you ten years to achieve, using your own resources. Competitors who have external finances may, in the meantime, come and push you out of business.
You have to be rational, when thinking about small business financing. You have to know (realistically) how far your personal resources can take you. Once you get to that point, you need to be open to external financing. That may be the only way in which you can take your business to the next level.
Desperation is arguably the worst thing you can have, when looking for small business financing. If you are too desperate, you may end up getting financing deals under very bad terms. You may end up taking small business loans at interest rates that are too high. Then you would have problems repaying such loans. Alternatively, you may end up giving up too much equity in the business, in exchange for too little capital. Thus, however dire your circumstances may be, you need to avoid desperation.
4. Overly hasty deployment of capital
This is another common small business financing mistake. Sometimes, small business owners opt to spend all their capital at once. They are left with no reserves. They do so assuming that their businesses will start bringing money instantly. Then the reality dawns on them. It soon becomes clear that the business will require (at least) some months, before it starts bringing in money. Yet they have already used up all the capital they had. The business then starts having cash-flow problems…
If no solution is found, the business often ends up failing in its infancy. Alternatively, the business owner ends up having to take external financing under duress. The business owner, for instance, ends up having to give up too much equity in the business, in exchange for financing. In other cases, the business owner ends up having to take a business loan at a very high interest rate. He ends up being willing to do just about anything to keep the business going. Yet he could have avoided this predicament. The most prudent thing would have been to set aside a certain percentage of the capital, as reserve. Not to spend all the capital funds at once.
The opposite of over-hasty deployment of capital is over-cautiousness. Some business owners are over-cautious in their usage of capital. They hold onto too much money, in the name of reserves. Their businesses then end up with inadequate capital. This means that the businesses start out weak. That has implications. Their businesses may be unable to get the best locations. They may be unable to get the best equipment. Or they may be unable to get the best human resources. All these things affect the business’ performance.
A balance has to be struck, between using up all the capital at once and being over-cautious in deploying the capital. In many cases, holding onto 20% of the capital as a ‘reserve’ is prudent. Then the remaining 80% can be deployed with confidence, to make the business work.