At some point in the life of your business, you will need to borrow money. You may borrow money from a bank, angel investors, or maybe even family. There are many different types of borrowing, so it is important to understand how borrowing affects your business.
Small business owners need to establish a good track record with a bank before it will let you borrow. Generally, banks will allow your business to borrow if you've kept a good track record for 2 years. A good reputation is often just the start. You should be prepared to provide the bank with a couple years of financial statements and a cash flow projection for the current year. The decision of whether to loan your business money is a mathematical decision made by the bank during its underwriting process. Accurate and well-maintained financial statements will not only help your business get approved for the financing it needs, but it could also provide your business financing at a more favorable rate of interest.
It takes several years for your business to establish its own credit score, so don't be surprised if the bank also asks you to sign a personal guaranty for the loan. Here, again, it is important to have accurate financial statements. You don't want to be held personally liable for your business loan. Accurate financial statements will tell you whether your business will be able to make the payments.
If you are unable to borrow from a bank, your next option may be family or friends. If this is the case, it is crucial that an agreement outlining the loan is created. Here, "handshake agreements" should be avoided. The agreement should include the amount borrowed, any interest that will be paid, and the date of repayment. The IRS requires a certain minimum amount of interest to be charged on all loans. Failure to charge this "applicable federal rate" will cause the loan to be re-characterized as a gift for tax purposes. Accordingly, if the loan is for a substantial amount of money ($14,000 is a good rule of thumb), you should consider engaging the services of a competent business lawyer to ensure the loan is documented appropriately. This agreement should be kept with other important business papers and a copy should be provided to the person loaning the funds.
If a bank will not let you borrow, and you cannot borrow from family or friends, you may use a credit card. A credit card can be used for large expenses such as equipment purchases. This is also a form of borrowing, since you will be paying interest if the balance is not paid off each month. Here, again, you will want to ensure you have accurate financial statements. Credit cards tend to carry much higher interest rates than bank loans, which can significantly hamper the cash flow of your business. Financing through credit cards should only be used as a last resort, and only if your financial statements indicate that your business can support the payments.
Finally, to help aid you in your borrowing, check your personal credit annually and try to establish business credit early in the life of your business. When your business is young, its ability to borrow will be tied to your own personal credit.
If you are considering taking on debt in your business, A to Z Accounting Services can ensure you are making that decision with the most accurate information possible. We provide thorough and accurate preparation of financial statements and analyze your cash flow to help you determine the amount of debt your business can handle. If you're already working with a bank to receive financing, A to Z Accounting Services can prepare the financial documents that bank underwriters need to close the deal. To learn more about how A to Z Accounting Services can assist your business with its financing needs, click the Contact tab to schedule a consultation.