Gregory S. DuPont
Borrowing Responsibly and Managing Debt
All business owners prefer to operate in the black. But, taking on debt is sometimes necessary as a company expands or when business slows due to economic volatility. Managing your debt carefully can minimize the cost of carrying debt and make it easier to move back into the black when the market improves.
Before taking out a new loan, make a list of your company’s assets that can serve as collateral, including real estate, buildings, and equipment. Then calculate how much financing your business needs, outlining precisely how you plan to spend the money. At the same time, review your current operations, looking for ways to cut unnecessary costs or increase revenues. You may, for example, be able to renegotiate payment plans with suppliers to allow more time to pay off the amounts owed. Similarly, if your company is planning to purchase equipment, consider whether leasing can reduce the amount you need to borrow. Review your invoicing procedures, ensuring that your system for collecting payments is effective.
After you have explored all options for increasing revenue and reducing expenditures, revise your business plan to reflect your current needs. Potential lenders often want to see evidence that your company is run efficiently and that market conditions justify additional outlays. Even if business is down due to the economy, you may, for example, be able to demonstrate that your company is outperforming competitors and is in a position to rebound quickly.
If you wish to borrow money, start by approaching your current bank. While an extension of a line of credit may be sufficient to meet the short-term need for additional cash flow, consider options for locking in a manageable interest rate for any long-term debt. If the amount of money your bank is prepared to lend your company is insufficient, investigate the alternatives. Because lending practices vary, consider applying for loans from a variety of banks, including large institutions, smaller community banks, and credit unions.
For smaller loans, consider approaching a nonprofit lender that provides micro-loans through a program of the Small Business Administration (SBA). These lenders typically extend lines of credit of up to $35,000 and may require applicants to provide evidence that they have been denied a bank loan. Online peer-to-peer lending may also provide a smaller loan. Individuals or businesses wishing to borrow funds on a peer-to-peer website post a listing for a loan, including information about the amount needed and the rate they believe they can afford. Potential lenders then bid to fund the loan, offering varying amounts and rates.
If you are unable to obtain financing through these channels, investigate other SBA loan programs. Distributed through commercial lenders, loans can be guaranteed by the SBA with favorable terms to qualified borrowers. The 7(a) program makes loans up to $2 million for a variety of purposes, including larger capital purchases or short-term working capital needs. While the loan itself is made by the bank, the SBA limits the interest rates and fees the lender can charge. All businesses that are considered for financing under SBA's 7(a) loan program must meet SBA size standards, be for-profit, be without the internal resources (business or personal) to provide the financing, and be able to demonstrate repayment. The maximum length of the loan is 25 years for real estate and seven years for working capital. Certain variations of SBA's 7(a) loan program may also require additional eligibility criteria.
The SBA’s 504 loan program also provides growing businesses with long-term, fixed-rate loans for the purchase of major fixed assets, such as land and buildings. However, the SBA may require personal guarantees from borrowers owning a certain percentage of the business. Visit www.sba.gov for more information on the types of loans available and the eligibility criteria.
In a challenging economic climate, your company may be in a very different position than the last time you sought financing. If an analysis of your current situation reveals a high debt-to-equity ratio, taking out additional loans or credit could expose you to too much risk. To avoid becoming too leveraged, consider looking for new investors. Depending on your needs, your capital requirements may be met through small investments from friends, relatives, business associates, angel investors, or employees. These deals should always be governed by a legal contract defining the terms of the arrangement, including the return on investment for stakeholders and the extent to which investors will be involved in running the business.
Many businesses often require financing for short- and long-term needs. Borrowing responsibly and managing debt effectively can help your company minimize the cost of debt you need to take on.