Preface: Additional credit is not always optimal. If you plan to borrow, you should have a realistic plan for repayment beforehand. Work with your CPA to calculate debt to equity ratio’s (book and FMV) and assess risks before signing on a term loan.
Counting the Cost – Business Loans
So you want a business loan? Borrowing money is always easier than repayment; be certain before you sign on debt agreements that you absolutely must have a loan, and understand the risks. If you don’t borrow, you won’t be a financial indentured servant, but if you don’t borrow, you won’t achieve the profit of financial leverage. As with any business decision, the cost of financial leverage should be carefully counted before discussing any borrowing, small or large. Most banks will require personal guarantees on business borrowing, so if business income fades, your personal assets are at risk.
What are the risks of borrowing money? First, you are taking risk with other money. Most banks and financial organizations that lend money are risk adverse. That is they want a consistent compound interest investment without financial volatility. You are guaranteeing their investment with your assets as collateral and guaranteed loan repayment efforts. Most bankers are quickly solicitous when your business financials lack positive cash flow should you be delinquent on payments may foreclose on your property. If you are cross-collateralized with multiple property or project loans, one loan in default leads to every loan in default. Financial conditions can deteriorate quickly with an over-leveraged business.
Yet if you absolutely must borrow for business purposes you should prepare a loan package to demonstrate to a qualified lender your level of seriousness. A loan package is an organized group of documents that contain all of the information required to obtain an underlying decision from a lender on your loan.
Company Information
A loan package begins with company information that includes detail about why you are in business and how you earn a profit. Company information should include details on how many years you have been in business, your level of industry experience, and your competitive advantages; a business biography of sorts.
Financing Purpose and Transparency
Next, your loan package should state concisely the exact purpose why your business wants to borrow money. You need to state more than “I want to acquire an asset.” You should detail how the new asset, i.e. Caterpillar D11’s, will permit you to increase efficiency on projects. Be honest in answering questions and providing full disclosure to inquires during the loan process; demonstrate the character in your business plan is worthy of the lenders investable assets.
Supporting Reasons for the Funds
State why your loan is the optimal investment of cash for the lender, i.e. “with an addition of 2 D11’s, my business can mine more rare earths in the US; the majority of rare earths are imported from China; domestic production reduces geopolitical risk for US strategic technologies.”
Loan Structure and Use of Funds
The terms and conditions of the loan are of mutual interest to both parties. The amount of the loan, the term or length of the loan, and the interest rate should be on paper, i.e. my business wants to borrow $3,500,000 for seven years at a fixed seven percent interest rate.
You must be prepared to defend why you want to borrow with supporting data and acquisition calculations. The loan package needs to state exactly what the borrowed money will be invested in, e.g. working capital, equipment, or real estate. You should provide a detailed schedule of cash uses for the requested loan, and cash sources for repayment. Most often lenders will want 25% collateral on a real estate loan and higher percentages on equipment and working capital loans.
Repayment
Perform your due diligence to estimate repayment terms and require cash flow. If you sign for the loan, you are responsible for repayment; count the cost. If you prefer to avoid risk, consider an equity investor in your business, i.e. an investor who is a shareholder or partner shouldering the risk a lender would require a personal responsibility guarantee. “Interest on debt grows without rain”. You would be well advised not to borrow money, or lend for that matter, without consulting a trusted advisor(s), .i.e. your CPA.
Summary: As with any business decision, the cost of financial leverage, and inherent risks, should be carefully counted before any borrowing, small or large.