Why starting a business on credit is not a good idea

Starting a business can be a daunting experience, especially when you are a new entrepreneur.

There’s lots of planning and decision making that goes into launch, and one of the most crucial decisions you’ll make is on the source of capital.

And as Richard Harroch, a venture capitalist and author on entrepreneurship, warns: “It’s almost always harder to raise capital than you thought it would be, and it always takes longer than you thought it would be, so plan accordingly.”

Most people advice you to borrow from friends and family – but sometimes this line of financing has been exhausted on other ideas that didn’t quite work out.

Your savings aren’t always enough, which often means the next available option is to get started with borrowed money.

But just how feasible is it to start a business on credit? We explore some of the drawbacks.

1. Divided attention

Any successful entrepreneur will tell you that you’ll need all the peace of mind you can get in the initial stages of your business.

Having a loan is not exactly a comfortable position for anyone – unless you’re an established wealth creator. This means that if you start your business on credit, you’re probably going to be stressed about repaying it throughout your business’ formative stages.

This adds to the already considerable pressure you’ll be under to get things to work.

Yet, the reality of starting a business is that you’ll likely overshoot the runway, your projections might not go as well as you thought they would and it will cost a pretty penny to get your name out.

In the midst of all this, having a loan to repay may draw your attention away from the slow and steady progress that’ll secure your future.

2. Predetermined timelines

All loans, by their nature, have contractual obligations and predetermined payment schedules.

For a business start-up, you don’t want to court legal suits over a breach of legal contracts; you want to focus on building a name for your business in your industry.

However, if you’re not able to pay a loan on time, you’re better off renegotiating terms, even if it means bearing a heavier burden in the long run, rather than waiting for lenders to come after you.

Business is seasonal, so working with a repayment schedule that doesn’t take into account the dips can be difficult.

3. The money matter

The early stages of running a business tend to take more than give. Different businesses take varied amounts of time to become profitable. It often depends on the type of business, the amount injected into it at the start and the type of industry it’s in.

This automatically means that in the early years, your focus should be more on building cash reserves rather than on withdrawing money from the business to pay loans.

Regular repayments, therefore, may destabilise the growth of the business and end up paralysing the start-up altogether.

4. Money discipline

Working to save up for the initial capital for your business can be extremely rewarding and less of a strain.

Apart from having no loan obligations as you run your business, you’ll learn the discipline of managing money before you even get your idea off the ground.

Nick Woodman, the founder of listed tech firm GoPro, recalls of his start: “Nobody likes to fail, but the worst thing was I lost my investors’ money, and these were people that believed in this young guy that was passionate about this idea .… (When you fail) you start to question, are my ideas really good?”

Woodman found his happy ending eventually, but not everybody gets as lucky.

You don’t want to lose out on your ideas just because you failed to pay off a loan. So, if you can, rethink borrowingand focus on other means of getting the capital. When you’re good and stable, and are sure a loan won’t throw your business off balance even in the worst-case scenario, then by all means find a lender you can work with.