Fiscal Fog

Don't know a loan from a line of credit? You're not alone--but we can help with a look at the most common financing myths.
Magazine Contributor
4 min read

This story appears in the January 2007 issue of Entrepreneur. Subscribe »

Entrepreneurs may have a keen intuition about their businesses, a clear understanding of the markets that move them, and a cool finger on the pulse of their industries. But when it comes to the capital they need to grow, many still have a lot to learn. According to a spring survey of small-business owners, part of the OPEN from American Express "2006 Semi-Annual Monitor," many entrepreneurs harbor a number of misconceptions about basic financing terms and the strategies that will put cash in their coffers. The following are a few of the more popular myths, debunked.

1. Financial credit options are all alike. More than a third of survey respond-ents believed a term loan and line of credit were pretty much the same--a mistake that could lead them to the wrong financial tool, and possibly to debt they can't afford. A term loan capitalizes a specific asset for a specific period of time. In general, you want to match the loan to the life of the asset you're buying, says Rebecca Macieira Kaufmann, executive vice president and head of the small-business segment of Wells Fargo in San Francisco. "If you knew you were remodeling a space that had a five-year life, then you'd want a five-year loan to match that depreciation," she says. A line of credit, on the other hand, is a revolving finance tool you can tap as needed. The lender sets a maximum amount of funds it will make available, and interest typically accrues only when you use the funds, says Jed Scala, vice president of small-business finance at OPEN from American Express in New York City. Its quick availability makes it ideal for short-term cash-flow needs.

2. My bank will save me. Almost half of entrepreneurs who completed the survey believed banks commonly make loans to loyal customers in the midst of a cash-flow crunch. That's not entirely false, says Tom Nist, senior vice president and manager of the small-business segment at PNC Bank in Pittsburgh, but it depends on the reason for the crunch. "If it's an issue of approaching insolvency, of not generating the revenue and so on, that's the kind of cash flow we'd be concerned about and probably not grant credit," he says. If, on the other hand, the sudden need is a result of rapid growth, revved-up receivables and a demand for more inventory or a new warehouse to accommodate the expanding customer list, "those are what we call positive cash-flow crunches, consistent with growing the business," says Nist. He recommends that before business owners undertake any significant growth plans, they discuss them with their banker so there are no surprises.

3. One egg, many baskets. Nearly 4 in 10 respondents believed it made good business sense to cast a wide net by applying for loans with as many lenders as possible. Sounds logical, but Scala points out that every request you make for credit shows up on your credit report. So if you're close to using up all your lines with other providers, all the requests for cash can hurt your chances of receiving financing by raising red flags with lenders' risk-management departments. "Instead," says Scala, "It's best to limit your inquiries to a small set of financial institutions at a time."

4. More money can fix whatever is wrong with my business. Nearly one-third of survey respondents said their biggest frustration was needing more money to grow their business and having difficulty finding it. In some cases that need is legitimate, but experts say that too often, business owners think more cash can crank up their slow business. "They oversimplify the problem and focus on needing more money when, in fact, they really haven't done a good enough job assessing what their business is, what the target markets are, how their business is running," says Michele Abraham, director of Ohio's Small Business Development Centers in Columbus. They also tend to focus on fast growth as a remedy, even when higher sales at the wrong price point can lead to a loss. Growth is good, she says, but "you really have to grow strategically."

C.J. Prince is a New York City writer specializing in business and finance.

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