by A.W. Berry

Created on: November 04, 2009

The disadvantages of small business loans aren't always made clear by lenders who may collect lending interest regardless of whether or not a small business fails. Between 2006-2008 business bankruptcies rose from 19,695 to 43,546 according to the American Bankruptcy Institute (ABI). Included in those bankruptcies are the approximately 50% of small businesses that are reported to fail within the first 5 years of operation by the U.S. Small Business Administration website (sba.gov). Some of the disadvantages of a small business loan can include 1) loan objective failure, 2) cost of the loan, 3) affect on business credit rating and 4) implication to shareholders.

* Impact on business credit

Creditors use total credit used in relation to total available credit in calculating credit scores. If this ratio is too high it could negatively affect future financing activities for the business. For example, if a line of credit or business credit cards are used to sustain daily operations during the cash conversion cycle and to facilitate accrual accounting, that credit may be negatively impacted by a business loan for another project. When obtaining a small business loan it is a good idea to assess any potential financial impact on other loans or credit.

* Loan non-performance

Small business loans can and do have pitfalls or disadvantages. The business plan which was used to obtain the loan could fail making the cost of the loan higher than the rate of return on the loan. Consumer trends can dip, cyclical markets may stay in downturns, and a long drawn out secular market may lead to potentially unsustainable leverage for a small business. In other words, it may be a good idea to build in a reasonable amount of cash flow redundancy into a small business in case forecasts and otherwise consistent projections do fall short.

* Cost of loan

Some loans simply are too expensive to be beneficial even if the loan is considered a calculated bridge to a future financial or business goal. This is especially the case with unsecured loans or small business loans with fiscally oppressive terms of agreement. A loan cost that exceeds the return on debt is usually a risky decision unless the loan is implemented in a solid two-step forecast. For example, a seasonal loan that allows a retail business to stock up inventory for the up season or continue operations during the down season.

* Implications to shareholders

If the small business has shareholders, the shareholders may be displeased

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