Ravi Chandran
The success or failure of your business can hinge on borrowing money responsibly
By: Hitesh Khan/
As you know, a loan is based on a simple idea: someone gives you money and you promise to pay it back, usually with interest. Loans are so common that you probably are familiar with the mechanics, but nevertheless it makes sense to review the basics.
The success or failure of your business can hinge on borrowing money responsibly: you want to borrow enough that your company can reach its potential but not so much that you have severe difficulty paying it back.
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It can be a mistake to pour too much money into your business at the beginning. A fair number of small businesses fail in the first year, so raising and spending a pile of money for an untested business idea can lead to much grief – especially if you’re personally on the hook for borrowed funds. Consider starting as small and cheaply as possible.
You have many options when looking a loan for your business. For small ventures, borrowing money responsibly means considering if friends and family members are willing to help. For sophisticated or mid-sized businesses, banks, cooperatives, and savings and loans may be willing to lend you money.
While a friend or relative may be willing to lend you money on a handshake, borrowing money responsibly would tell you that this is a bad idea for both of you. It’s always a better business practice to put the loan in writing, and to state a specific interest rate and repayment plan. Otherwise, you open the door to unfortunate misunderstandings that can chill your relationship.
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If you want to borrow money responsibly, you should also know how interest rates on your loans work.
Interest is a percentage of the amount that you owe that is added to your balance periodically as a fee for using the money. It will continue to accumulate until your debt has been repaid.
Interest rate is the percentage of the debt that is charged as interest. Every loan, mortgage, credit card, or medical bill that you ever will receive will have an interest rate associated with it. These can vary wildly between financial products, and also between consumers based on their credit histories.
It is very important for you to know how interest works, because otherwise you might not understand why your balance never seems to get any lower even though you are making payments, or just how much your debt really is costing you.
Interest rate is a fact of life, so understanding how they work is crucial to financial planning and debt repayment. Do not ignore the power that compound interest can have on your debts, but also remember that interest can work for you just as well as against you!
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Personal guarantee is an inherent part of borrowing money responsibly but there are many ambiguities and misunderstandings that surround the topic of personal guarantees.
A personal guarantee is an unsecured promise from an individual to make loan payments when a small business is not able to do so. “Unsecured” means it is a promise that is not backed up by a specific asset, such as real estate, in which case, the asset would be considered collateral.
A personal guarantee is an added assurance that you are serious about your business – and most importantly – serious about repaying the loan. One big reason why a personal guarantee is needed is because most lenders are bankers and are in the business of accepting deposits. They use those deposits to make small business and other loans, and, as a result, they are responsible for protecting the interests of their depositors.
Be mindful that while your small business may be a borrower, you are also a depositor. As such, you would be affected if an unscrupulous small business owner borrowed your company’s deposits and did not bother to repay them.
A personal guarantee is a psychological reminder to you of your company’s obligation to make timely payments and eventually repay the loan. If it fails, you are responsible. A personal guarantee shows your commitment to being a responsible business manager and repaying your business loan.
Financial affairs of a small business are commonly intertwined with the personal financial affairs of its owners, so it is logical and reasonable to ask you to promise to repay the loan, if your company cannot. A personal guarantee offers lenders the ability to follow the due process to recover the business loan from you personally.
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