Many businessmen consider debt financing as a need for small business growth and expansion, yet there are a number of risks connected with funding a firm from any source other than earned income. If debt financing is not effectively managed, it can place a significant strain on businesses and their owners. To avoid the following problems, manage your company's debt prudently and get informed with the hazards of financing a small business.
Things to Consider before getting a Small Business Loan in Dubai
If you plan to use a small business loan in Dubai to fund your new venture, be sure you have the five C's of credit covered: Collateral, Character, Capital, Capacity, and other lender-imposed requirements. Before you go in to submit your application, though, be aware of the hazards associated with different types of small business loans in Dubai.
Unless it's a variable rate loan, a normal small business loan in Dubai (term loan) requires you to make a regular monthly payment for a specified length of time—the payment amount and terms don't change over time. Some banks will provide you with a line of credit to assist you fund your small business, similar to what homeowners receive for home improvements and other needs. The payment varies depending on the owner's preferences. Apart from the consequences of default, which may include the seizure of your assets and collateral, one of the risks of taking out a small business loan in Dubai or line of credit from a bank is that the bank may require you to open a business bank account and make automatic withdrawals to pay the obligation, which the bank may be able to garnish if you default.
Risk Involved in Small Business Loan in Dubai
Some of the Risk involved are as follows-
The personal liability inherent in a sole proprietorship or partnership's debt is one of the most significant financing concerns for a small business. If your company goes out of business before it can pay its debts, you may be left with a personal financial load that may take years to settle and may even result in personal bankruptcy. To prevent acquiring too much debt before your company model begins to sustain your operations, finance growth at a slow pace in the first few years of operations.
If you rely on debt financing too much, it can hurt your personal or business credit score if you don't make timely payments. Missed payments, defaults, and debt restructuring all affect your credit score. Avoid taking up too much debt; instead, pay off a few creditors at a time before borrowing from anyone else.
Interest Rates Risk
Any borrowing transaction carries the risk of shifting interest rates on new loans. If you borrow at a fixed interest rate before the current rate on new loans falls, you can end up paying more in interest than competitors who borrowed at lower rates. This can result in a loss of opportunity for your company, reducing profits that could be obtained by paying a lower interest rate. This element can, of course, work in your advantage if interest rates rise after you've signed a loan deal.
Large investors, such as venture capital firms, frequently force you to relinquish ownership of your company. According to Business Knowledge Source, while an investor owns a part in your company, he will certainly have a lot of influence over organizational strategy and decisions. This can lead to strategic decisions that are at odds with your original vision, typically in the pursuit of short-term profits at the expense of long-term viability. To recover managerial control, you must finally buy out an investor's ownership stake at a price that is far higher than the original investment.
If you decide to use a stock issue to fund your small business, you will face a number of dangers associated to firm ownership dilution. Unlike angel investors, who have one or a few investors making managerial decisions, a publicly traded corporation must cater to the interests and desires of hundreds or thousands of individual shareholders. The right to vote on board member elections is normally reserved for stockholders, and board members have the power to designate important executives. Executives are in charge of the company's operations. This technique has the potential to cause the original business owner to lose entire control of the company.
Loan with a Credit Card
A cash advance from a small company credit card is available to small business owners. Because of the higher interest rates associated with credit card accounts, the uncertainty of credit card terms, and the fact that this is a revolving account, this loan is dangerous. There is a tendency to keep spending available funds in a revolving account, which could result in a long-term small business debt.
If the company has adequate collateral, a business loan may be issued. The most common form of collateral is assets that are used to secure the loan. Some of the assets that a company might utilise include, but are not limited to:
- Bills receivables
- Real Estate
What makes this a danger? Because if the loan isn't returned according to the terms, the lending firm or bank will seize ownership of these assets. The company's equipment may be critical in generating the cash flow required to repay the loan. If that equipment is seized, it will be difficult for them to operate, and they may eventually go out of business. Land and real estate are in the same boat. Because account receivables are revenues earned but not yet received, this might be a major problem for them because they would no longer be entitled to them.
Interest Rate fluctuation
Depending on the type of business loan, the corporation may be required to repay both the principal and interest. This is common; however, the amount of interest paid varies depending on the type of loan. A fixed-rate loan means the company will pay a fixed amount in interest over the loan's tenure. This is definitely the best option because knowing what your monthly payments will be makes budgeting easier. A variable rate loan has an interest rate that might fluctuate throughout the loan's term. This is a concern because it could result in increased payments, which could lead to repayment troubles.
Default on a loan
The act of defaulting on a loan is simply not repaying it or making late payments. In either case, a company's inability to make monthly loan payments is not a positive indicator. Because of increased interest rates, reduced loan amounts, and other concerns, it would be difficult to secure fresh loans or services if it was not returned. A defaulted loan has a negative impact on the company and its owners until it is resolved.
Occasionally, a company will discover that it can acquire many loans at the same time or over time. However, just because a company has the ability to do so does not imply it should. What makes this a danger? The dangers are reduced when loans are repaid and new ones are received. This would assist the organization in establishing a strong repayment history. However, if they secure a loan and then borrow more before the initial loan is returned, it could indicate that the company is experiencing major financial difficulties
When a corporation borrows money on a regular basis, it raises the question of whether it is profitable. If they aren't, it'll only be a matter of time before they declare bankruptcy and close their doors. This would also call into question the owners' and managers' financial management abilities.
There are pros and cons to pursuing a Small Business loan in Dubai, such as issues with ownership, eligibility, risk to personal credit, and the cost of repayment. However, qualifying for a small business startup loan could mean having money to start a company unattached to loved ones expecting repayment, or investors who will want ownership in exchange for their investment.
Small business owners should weigh all considerations before deciding to move forward with this loan option. Have you pursued business financing as a new entrepreneur? Or did you wait until you had an established business before applying for additional funding? For further guidance you can connect to our experts at Dhanguard.