When Collin Slattery, 26, needed cash to grow his New York City-based digital marketing firm Taikun at the end of 2014, he turned to an alternative lender to borrow about $10,000.
Even though the fees amounted to a 44% annual percentage rate, Slattery chose the loan because he had seen how hard it was for more established small businesses to win a traditional bank loan. After taking out a second loan for about $2,000 in March, his firm still owes money to the lender. He hopes to make the last payment this month. In the meantime he has trained himself to ignore marketing that entice, “You’ve got $15,000 waiting for you now” or promise him a $300 a gift card if he borrows more.
“It’s very hard to get a positive return on that money when it’s so expensive to take,” says Slattery, who adds that his firm should generate $250,000 to $500,000 in revenue this year.
Meanwhile, he juggles his loan payments with cutting paychecks to his one full-time and one-part time employee and a crew of contractors—all while paying himself just $30,000 a year.
Many entrepreneurs have similar regrets about early decisions they make about using credit in their startups. It’s not surprising, given how much there is to learn when one is starting a new business and how many roles a CEO has to juggle.
That said, it pays to get a crash course. Many newbie credit mistakes can put you out of business and make it hard to get additional credit. According to the 2013 Global Entrepreneurship Monitor Report, produced by Babson College and other universities, challenges obtaining financing were one of the top reasons businesses in the U.S. fail.
Here are some credit mistakes that can lead you off course and tips on how to avoid them.
Fuzzy math. Not knowing exactly where you stand financially can lead to late payments that damage your credit score. If you’re great at running your business—whether you take care of pets or sell clothing—but a sloppy bookkeeper, hire a pro to keep you on track. Besides helping you avoid problems like missing payroll or failing to pay the proper taxes, running a tight financial ship will make it easier to secure credit when you need it.
“It is pretty clear at the time we make a loan who has gotten themselves organized,” says Hunter Stunzi, co-founder and president of SnapCap, a lender based in Charleston, S.C. that works with many small firms. “When we’re on the phone with them, they can rattle off where they are spending money and why.”
Using credit as a crutch. If you aren’t bringing in enough revenue to cover your overhead after an initial startup period, don’t assume borrowing is the answer. You may need to tweak your product, service or business model.
“Credit is supposed to be your fallback plan, not your lifeline,” says attorney Andrew Sherman, a partner at Jones Day in Washington, D.C., who advises businesses of all sizes. “I see a lot of small companies overusing or abusing their lines of credit at time they really should be financing through their revenue. They either don’t have the revenue or they are misusing their credit line. No one has walked them through when to be hitting the line of credit and when not to.”
Not sure? Ask your accountant how much money a business with your revenue and cash flow can safely borrow—and under what circumstances. When in doubt, do a reality check. Ask yourself, “Why I am I drawing on this credit and what is the likelihood I’ll be able to repay it quickly?” suggests Sherman.
Maxing out credit cards. Even if you don’t borrow a large amount of money on your credit cards, it’s possible to hurt your credit score if you utilize too much of your credit all at once. Ask Brandon Baker, co-owner and head chef of Loveletter Cake Shop in New York City, which makes special-occasion cakes. Baker, who has already started several businesses, knew it was a good idea to limit the amount he borrowed to launch the now 2-year-old business. He put the $7,000 he needed for costs such as a commercial–size mixer on a credit card with a $10,000 limit.
Baker was unhappy to discover that utilizing this much of his available credit lowered his credit score. He quickly found a solution: Applying for two other cards and taking advantage of zero-interest balance-transfer offers to spread the $7,000 he borrowed among them. That resulted in lower utilization of his available credit and no cards that were near the max. “It ended up working on all fronts,” says Baker. “The APR was lower on the second card, and the other card has 6% cash back at supermarkets, which is great for us.” He also restored his good credit.
Trusting clients and vendors too readily. It’s tempting to hope for the best when conducting transactions with new business contacts, but that can result in big financial losses. You’re better off protecting yourself through practices such as requiring deposits and payments midway through big projects—and negotiating deals where you pay for major purchases once you are satisfied with them.
Emile Maroun still recalls paying up front for more than $300,000 for seeds for his tahini company, Sunshine International Foods in Methuen, Mass. in 1999—and then receiving the wrong ones. He couldn’t use them, and the vendor, based overseas, would not rectify the situation. “It cost me $60,000 for lawyers,” he says. “They could do nothing.”
Maroun now sticks to domestic vendors he knows. Fortunately, it’s gotten easier to find the seeds he needs in the U.S. “We have everything here,” he says. “Why go elsewhere?”
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