When is the right time to take out a business loan?

We’ve all heard conflicting messages. Capital fuels growth, credit creates a modern economy, but business and personal debt are skyrocketing. Timing is often everything when it comes to deciding when to take a loan. As a multiple-time business owner, I’ve seen the good, the bad and the ugly of loaning money.

More lending options than ever

Although the situation changed during the global financial crisis of circa 2008/2009, today there is an increasing number of lenders willing to loan to small businesses. The flood of lenders has reduced the barriers for securing a business loan. Loans are now available with reduced documentation, to those with a bad credit history and those without security such as a physical asset.

Even the Australian Government is expanding lending opportunities for small businesses. In 2018, $2 billion was allocated to a “securitisation fund to provide loans to small business through smaller banks and non-bank lenders, plus a business growth fund that will enable big banks and super funds to take passive equity stakes in small business. The assumption is more money will help small- and medium-sized enterprises fund their expansion plans”

So, when is the right time to take a loan?

The question is complicated and depends on factors such as the type of business, its maturity, how effectively it can use the money, and the financial position of the business. It’s not easy to get the timing right when faced with the usual challenges and stresses of running a small business.

Some examples of good timing include:

• A new business that requires equipment, inventory and staff before it can start generating revenues.
• A customer base that can’t be fully addressed without expanding inventory, adding a location or expanding production.
• Strong demand that requires an expansion of staff, better pay to secure qualified staff or extended employee hours.

Some examples of poor timing include:

• When an opportunity looks good but may require large amounts of additional debt and provide only short-term benefits causing more harm than good.
• During times of financial pressure when a loan is used to cover existing expenses or debt payments. Are there fundamental issues with the business that the loan is helping to cover? 

Too early, too late or just right

Securing a loan:

• Too early before you’re ready to use the money may affect how detailed your planning has been and your ability to offset the loan repayments with associated revenue growth.
• Too late and you could miss the expansion opportunity or limit the additional revenue created.
• Ideally, you’ll time the loan just ahead of when you plan to use the money and use it appropriately in line with the right reasons. 

You also need a plan for how to use the money

Even if the timing is good and your reasons are sound, you’ll need an expansion plan of how to best use the money. For example, details of where to spend the money and the timing – without stressing the business with too much change too fast.

The results of the Australian Bureau of Statistics first management capability survey highlighted that less than a third of small businesses have a plan on how to expand. Providing more money doesn’t necessarily help grow the business without an understanding of how to expand and having a plan for expansion.

The good, the bad and the ugly

Below is a research project conducted by business finance experts, Max Funding, which shows the two real world examples of Australian small business that highlights the good and bad timing/reasoning:

The first was a technology services business that spent the first two years of its operation slowly growing and establishing itself. It took its time to understand its market and customers, build up customer demand and optimise its operations. The business took out a loan in year three to expand its channel partners and improve efficiencies by automating processes using technology. After these changes, the business was able to scale quickly and experienced a six-fold spike in revenue in the first year after the loan, and year on year doubling of revenues before being acquired after six years of business.

The second business was a business consultancy that had been operating for twelve years. It dipped in and out of profit with the owners reducing or increasing their salaries to manage the fluctuations. The company had a long-term relationship with its bank and was offered a sizable business loan. The company utilised the money for covering shortfalls in its revenue. It didn’t address fundamental business issues such as decreasing customer demand or aligning this with corresponding cost reductions.

The company hadn’t planned for how to best use the funds to stabilise or grow the business. As a result, the loan just contributed to the debt levels and expenses of the business driving it into financial trouble.

Getting it right

Determining the right time to get a loan requires an understanding of your current financial position and a plan on what to do with the money. If the loan is being used to cover over the cracks caused by fundamental problems within the business, it’s probably not a good idea. Otherwise, the best time is sometime shortly before you need to use the money and once you’ve carefully planned for your expansion.