Business loans and lines of credit are viable sources of funding for small businesses. You can use funds for day-to-day operations, expanding into new markets, or purchasing materials and inventory. In some cases, the first loan doesn’t cover all your business needs. That’s when small business owners look for other sources of funding, including loan stacking.
What is loan stacking?
Taking out more than one loan at a time is called loan stacking. It happens after a business has already used the funds from one loan and needs to apply for additional funding from a second lender. This could occur when the original funding needs were miscalculated, when the cost of doing business goes up, or due to poor cash management.
The need for additional funding before a first loan can be paid off is an indicator that small businesses need to evaluate their costs and cash management strategies. Loan stacking might seem like the only option when the bills are piling up, but sensible budgeting and seeking out other finance options could be a better long-term solution. We’ll cover more on that below.
Why shouldn’t I stack business loans?
There are several reasons why loan stacking is not a good practice for small business owners. It can damage your company’s credit rating and could make lenders reluctant to offer you additional funding in the future. Here are some more specific drawbacks to loan stacking:
1. Loan stacking increases your risk of defaulting
Taking on too much debt puts your company in a difficult financial position. Each loan requires a monthly loan payment, and multiple loans increase the risk that you’ll default. There could come a time when your business is working just to pay off debt.
2. Additional loans will have higher interest rates
Lenders set interest rates based on debt-to-income ratio. Additional loans will likely come with higher rates and could send your business into a debt spiral. If your company is public, you could even lose shareholders.
3. You may violate your original loan agreement
If you violate the terms of your initial loan agreement, you could automatically default on that first loan. If your initial loan is a business line of credit, your lender might put your account on hold and revoke your ability to request draws.
Other financing options for your small business
There are some basic rules when it comes to business funding. The first is to try to do business with only one lender. Building a strong relationship with a banking partner can help solidify your company, especially as you’re looking to grow. Loan stacking undermines that relationship. A better option would be to go back to your original lender and ask for more funds or a second loan from the same source.Another rule of business funding is to never take on new debt to pay off old debt. It’s better to cut costs and streamline expenses until the original loan is paid off. If that’s not possible, ask your original lender for a business line of credit and use it to increase revenue. Combine that with a stricter budgeting process and you could avoid falling into a debt spiral––plus maintain access to much needed funds in the meantime.