6 Common Risks of Financing a Tech Business
In many cases, business financing is necessary to help a small business grow and prosper, but there are several risks associated with financing a technology company with anything other than earned income.
If not managed properly, debt financing can impose a critical burden on small businesses and their owners. Do familiarize yourself with all of the possible risks associated with financing your small business in order to avoid potential pitfalls.
1. Credit Score Risk
When you rely too heavily on debt financing can leave a detrimental impact on your company or personal credit score if you are unable to make reliable payments. Missed payments, restructuring, and defaults will all lower your credit score. Always focus on repaying creditors before borrowing from elsewhere, and don’t take on debt from too many sources at once.
2. Personal Liability
The personal liability implied by partnership debt or sole proprietorship debt is one of the biggest financing risks for a small business. If your business closes before you are able to pay off its debt, you could be held responsible to pay back a personal debt burden that will take several years to repay, and you might even be forced to file for personal bankruptcy. Borrow at an easy pace for the first few years you are in business in order to avoid accumulating too much debt before your company can sustain operations.
3. Incorporation Risks
If you decide your best option is to finance your small business through a stock offering, you face several risks that are related to diluting company ownership. Instead of having just a few investors making decisions for the management of the company, a publicly traded company has to serve the wants and needs of each of the individual owners. This means stockholders have the right to vote in a board, the board members have the power to appoint executives, and the key executives will control your company’s operations, which could cause you to completely lose all control over the business you started.
4. Investor Control
Large investors like venture capital firms will quite often make you give up some of your ownership in the company. While he or she owns a stake of your business, that person will hold control over decisions and organizational strategy. This may cause your company to go in directions against your wishes, quite often at the expense of long-term sustainability in favour of short-term profit. When this happens, you will have to buy out that investor’s share, typically at a price much higher than what they originally paid, in order to take back managerial control of your business.
5. Interest Rate Risks
In any borrowing transaction, the fluctuating interest rate is always inherent. If you borrow at a fixed rate just before interest rates go down, you could be paying a lot more in interest than someone who borrowed at a lower interest rate. This will cut into your profits and impose an “opportunity cost” on your company, which you would not have had to pay at a lower interest rate. Of course, fluctuating interest rates can work in your favour if you borrow before rates shift higher.
6. Garnished Accounts
Aside from the risks of seized assets and collateral, another risk of financing for your small business is when a bank lends you money or offers a line of credit, they can require you to sign up for a business bank account from which they will make automatic withdrawals for the debt. If you default, the bank may be able to garnish that account.