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Why Term Loans Are Not Appropriate For Startups

Term loans

Why Term Loans Are Not Appropriate For Startups

Why Term Loans Are Not Appropriate For Startups

Updated: Dec 9, 2019

Imagine you launch your first business at the beginning of the new year. By mid-year, the enterprise is close to finding its feet. Traffic is impressive, but while the revenue generated covers a significant percentage of expenses, external funds are still required to balance the books. You have a hunch that a product line extension would greatly increase the business’s revenue potential. Could a term loan be the key to pursuing that opportunity?

A term loan should enhance business operations without placing undue pressure on cash flow. With that in mind, a key component of a lender’s underwriting process is analyzing business financials to verify that the cash generated will be able to support the loan payments. Without access to financials over a meaningful period of time, the accuracy of any financial projections is limited. At Funding Circle, we look to have at least two years of operating history, because that gives us two sets of data to understand the cost structure of your business and identify growth trends and consistency. The last thing we would want is for you to unknowingly take on too much debt and threaten the future of your growing business.

Two years is also enough time to build a prospective lender’s confidence in your ability to manage and guide the growth of your business. According to the US Small Business Administration, only 66% of new businesses survive the first two years of operations. Of the 34% which fail, many result from the founder’s inexperience. A lender’s belief in the fundamentals of your business is always a prerequisite for favorable loan terms.

So, going back to your new business, what would make it an attractive prospect for a term loan by the end of its second year? Adopt proper management practices from the start. For example, invest in the necessary capabilities to keep your books in order. Address minor issues in your credit history before they turn major. Outstanding tax liens and past due payments, for example, should not be left unresolved. Focus on attaining profitability. Evaluate your operations consistently to identify new areas for improvement. If financing is imperative to achieve this goal, consider taking on equity investors for your business. Most importantly though, build a dedicated community of clients and advocates.

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