Many entrepreneurs feel as though their survival hinges on landing a small business loan, whether it be an SBA loan or one from some other source. After all, most mainstream media and academics tend to claim that “running out of cash” is one of the leading causes of small business failure – if not the single biggest reason.
However, our hands-on experience with and research of small businesses suggest that cash is not the reason most businesses fail. Instead, cashflow issues are typically symptoms of deeper root causes. Much like person dies because their heart stops beating or they stop breathing, those are merely symptoms caused by some other disease or problem.
With this in mind, I tend to believe that cashflow issues are not what small businesses should be most focused on, especially in the early startup stages. Startups landing millions of dollars of capital are often glamorized in popular media such as Shark Tank, but in general, small businesses are often better off without outside capital.
Here are three reasons why small business loans can be a bad idea:
Small business loans increase your fixed costs and drain your cashflow. Cashflow is a precious commodity for any new business, so it may seem ironic that we would make this statement. However, small business loans typically increase fixed costs via a relatively high monthly payment, and this happens at a time when most small businesses can ill afford such fixed costs. To add insult to injury, most bank loans – including those backed by the Small Business Administration – entail conditions that restrict your ability and flexibility to creatively manage cashflow along the way.
Bootstrapping is good for small business. When you’re playing with someone else’s money, you are naturally not going to be quite as diligent as if it were your own. While funds from a loan may seem like your money because you are borrowing it from the bank, the reality is that you are not as likely to tightly manage your cash when you have a relatively large balance in the bank account. Companies that bootstrap, on the other hand, have no choice but to be very deliberate about how and when they spend their money. In other words, bootstrapping forces you to become profitable more quickly and to better manage your cash at the same time.
No small business loans = tighter financial controls. Similar to the second point above, a lack of small business loan means that you are more likely to have tighter financial processes and controls in place. While a lending bank may require you to satisfy certain conditions, it is easier to institutionalize tight financial controls and discipline when you have no choice but to do it because it’s your own money. As I’ve heard from more than one successful entrepreneur: “money can hide a lot of the warts.”
Of course, there is a time and place for small business loans. Once you have proven your product or service and business model on a more limited basis, a small business loan may be required to fuel your small business growth and to take your company to the next level. Or, if you are a capital intensive business, such as a producer of a physical product requiring high inventory levels, then small business loans can make sense. However, it is important to make sure that you understand why exactly you need the loan, what you are going to use it for, and ensure that it isn’t merely going to hide other problems in your business.