The Top 10 mistakes business owners make when financing their business.
“The essence of success is that it is never necessary to think of a new idea oneself. It is far better to wait until somebody else does it, and then copy him in every detail, except his mistakes.” Aubrey Menen
Business owners typically make one or more mistakes when trying to obtain financing for a new business or expand or grow their existing business. Most business owners don't even realize they are making a mistake until it is too late and their business has already been red flagged. By simply educating yourself it is possible to avoid these costly mistakes. To help you avoid these mistakes I've provided a list of the top 10 mistakes business owners make when trying to obtain financing. These mistakes can cost a business a lot of time and money. And in some cases could result in a red flag high-risk status with D&B.
Mistake #10
Not doing your due diligence.
Most business owners do not follow up with Dun & Bradstreet to make sure all their information is correct, and all their trade references are being reported. Remember most vendors do not report trade experiences to Dun & Bradstreet. It is important to make sure you have five trade references that report to Dun & Bradstreet. I recommend you review your business credit report from all 6 business credit reporting agencies on a regular basis to make sure all information is correct, there is no conflicting information, and all trade references are being reported.
Mistake #9
Being too anxious to obtain financing and rushing through or skipping any one of the seven steps.
As I said in the seven steps chapter the implementation of each step is very critical, rushing or skipping any one of the seven steps could result in a red flag or high- risk status with D&B.
Mistake #8
Using business credit to supplement income
Although business credit can come in handy in months when the business doesn't do so well. It cannot be used to supplement income, business credit is a loan issued to your business, and just like any other loan it has to be paid back with interest.
Mistake #7
Using business credit for personal use
When you use business credit for personal use such as a car, T.V., or a boat etc. you are not receiving any return on investment (ROI). In fact you’re acquiring a liability that causes more expenses. The use of business credit for personal use is illegal. To get around this it is possible to have the corporation issue you a loan with a very high interest rate of course more on this in the protecting your assets chapter.
Mistake #6
Forming a business entity and establishing business credit that is not separate from your personal credit.
Most business owners are operating as a Sole proprietorship or a General Partnership. These business entities offer no liability protection for personal assets. The business and the business owners are one. Which means you are personally held liable for your company's debts and actions. In other words if you're SUED you're SCWERED. Most business owners personally guarantee loans on the business's behalf. In the first and second stage of developing a business it is common to be asked to personally guarantee a loan. But after you've established a
Duns Rating, and a Paydex score of 80 or better, and have been in business for at least 5 years you should no longer be asked to provide a personal guarantee.
Mistake #5
Using close friends and family’s funds.
If you inconvenience your family members and close friends to finance your business you are digging yourself a deeper hole to crawl out of. Now in the event of your business failing as 97% of all businesses do in the first five years, not only will your business have failed. But you will have dragged your friends and family into the whole mess as well.
Mistake #4
Not paying company bills on time
Not paying your companies bills on time will dramatically bring your Paydex score down. Unlike the Fico score, which is only affected if you pay 30 days after your due date. The Paydex score is based on your average days to pay. Meaning every day beyond the terms agreed your payment is not received, your Paydex score drops. So if you pay two days beyond the terms every month on all your trade references that report to D&B your Paydex score would be 79. And if you pay three days beyond the terms your Paydex score would be 78.
Mistake #3
Applying for credit and not knowing lending institutions loan criteria.
Most business owners apply for business credit without knowing whether or not their company is in compliance with the lending institutions lending requirements. You should have completed the first six steps in the Seven Steps Chapter before you start applying for business credit. Lenders say that businesses in the third and fourth stage of the development process are ready to approach commercial banks and other traditional lending institutions for financing. Businesses in the first and second stage of the development process should seek financing from informal investors such sources of funding may include private investors, Venture Capitalists, Angel Investors, government grants etc. for more information on lending criteria refer to the bank loan criteria section in the business loans and commercial finance Chapter.
Mistake #2
Pledging personal assets
Any time you pledge your assets such as take-out a HELOC on your house, or borrow against your life insurance policy or 401(k) to finance your business you are putting your personal assets at risk. If the business cannot repay the loan, the bank will put a lien on your home, or your life insurance policy will be wiped out etc. The only time you should pledge your personal assets is if the lender requires it and it is the absolute last resort. Operating as a sole proprietorship or a General partnership also puts your personal assets at risk. To take it one step further one should not own or have any personal assets. Instead have a trust, or a corporation own the assets that no one knows you control besides your lawyer. (More on asset protection in the protecting your assets chapter).
Mistake #1
Using personal credit to finance your business.
If you have used your personal credit or personal funds to finance your business don't worry you are not alone. The number one mistake business owners make when financing their business is using personal funds or personal credit. When you use personal funds to finance your business, everything rides on the company's success, if the business fails you lose the investment you put into the business. In some cases it could result in bankruptcy. The more debt you have on your personal credit report the higher your debt-to-income ratio, it doesn't matter if it's for personal use or business use. Too much debt will lower your personal Fico score. You're also lowering your personal Fico every time you apply for business credit using a personal guarantee. See every time you apply for credit whether it's for personal use or business use, your hit with an inquiry, an inquiry can lower your personal credit score anywhere from 1-3 points. The lower your score drops and the higher your debt ratio the harder it is to secure financing… especially financing with the most favorable terms.
Chapter 9