Ami Kassar: The Perils of Borrowing Too Much, Too Soon; The reason for taking out a small-business loan should be to get your venture to the next level, not the next 10 levels

Ami Kassar: The Perils of Borrowing Too Much, Too Soon

The reason for taking out a small-business loan should be to get your venture to the next level, not the next 10 levels.

AMI KASSAR

Jan. 21, 2014 3:56 p.m. ET

Imagine a scenario where two entrepreneurs are sitting in a classroom planning similar ventures, but with different approaches. One is far sighted and has a picture of the equipment and factory he will need to build the widgets he wants to sell. This entrepreneur is building a forecast, projections and business plan. He is looking up prices for equipment and leases for buildings to figure out how much money he will need to borrow or raise.The other entrepreneur is short-sighted. He wants to sell to his first customer. As soon as he has an order, he is willing to have someone else make his product, even though outsourcing his production will eat up some of his margin.

The entrepreneur who is planning far into the future needs $500,000 to start his business and faces a long tough battle to get it. The other one needs just $10,000 and can get it from a credit card. They’re off to the races.

Small-business owners and entrepreneurs need money for a variety of reasons, but many think in too grandiose terms when estimating how much. The reason for taking out a loan should be to get your business to the next level, not the next 10 levels. A loan is not a substitute for generating income, nor is it a permanent crutch. People who see it as a crutch are probably in much more trouble than they realize.

Risk takers and dreamers by nature, small-business owners and entrepreneurs often let their visions of grandeur cloud their judgment when considering how much money to borrow to start a new venture or get a company out of debt. They make investments early on that are not crucial to their success, such as to hire a marketing guru or buy their own warehouse. Such far-sighted entrepreneurs tend to get stuck in their own delusions of how much money they really need, focusing too much on the future and not enough on the now.

A business owner who makes a niche product would likely be better off finding a co-packing facility and looking for funding based on purchase orders than seeking out millions to build her own facility. The dream for the facility is there, but the need for it is

Before getting too deep into the process or too excited about the prospect of a huge commercial-bank loan or U.S. Small Business Administration-backed loan, take a step back and ask yourself tough questions like: Will you make enough income from the loan to be able to comfortably pay the loan back over time? Do you understand the financing options? What are your goals for the next year?

Once you’ve got a clear understanding of how much money you need and for what, and have a clear plan about how you will be able to pay a loan back, then you are ready to talk to lenders. The decision to take out a loan, and for how much, is not a decision that should be made over a cup of coffee.

Many small-business owners and entrepreneurs are not ready to take on the amount of money that they are asking for, but buy into the delusion that a large sum will solve their problems without consequence. Thinking in smaller steps lifts the financial burden and often results in more success than being convinced that it’s all or nothing.

And, even after you’ve answered some hard questions about your business needs and goals (and personal needs and goals), there is still the issue of how much money you will actually qualify for when seeking out a traditional or alternative loan.

Many small-business owners and entrepreneurs lack the business credit, collateral or home equity that they need in order to qualify for the dollar amount that they are seeking. A business owner who is looking for a $200,000 loan but only qualifies for $75,000 will likely have to make some tough decisions regarding his business once this reality sets in. The faster you can find your equilibrium, the less time you will spend in the money hunt and the faster you will be able to take your business to the next level.