What about Using Credit? Part of the “I Don’t Know What I Don’t Know” series

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No business owner wants to borrow money.  It strains your emotions, costs you interest, and eats up valuable staff time.  Properly used, credit can be a boon, because it can propel your business to the next level.  Or maybe it’s a safety net so you can sleep at night.  On the other hand, if you borrow too much, or from the wrong people, you might be worrying about how you’re going to pay them back!!

Here are some special things that you should know:

  1. Credit costs money – Borrowing money costs more than just interest.
    1. Origination Fees – If you’re borrowing from the bank, they charge you to initiate the loan.
    2. Commitment Fees – They charge you for funds that you DON’T use.  The bank needs to reserve money for your use.  They charge you to have it available.
    3. Attorney’s fees – You may pay for the bank’s attorney’s fees to draft the loan documents.  Be sure to cap those fees.  If there is no cap, the bank is not concerned about how much time the attorney spends writing the loan docs.
    4. Field Audit – The bank charges you for their annual field audit.  They send someone to check the accuracy of your records, and verify some ratios, and you pay for it.

  1. Increased Reporting –
    1. Monthly financial reports will be required.  You will need to give the bank an income statement and balance sheet every month, by a particular date – 15 or 20 days after the month closes. You might also need to give them a Cash Flow Forecast.
    2. There may be financial covenants.  These are ratios or thresholds for income, payments, or tests of financial strength that show if you are able to keep paying your bank loan.
    3. They may require that you fill out a Borrowing Base Certificate.  This is a quick listing of your assets, your inventory and accounts receivable.  This shows the bank that you have the financial strength to pay them back.

  1. Personal Guarantee – There was a time when you could walk into a bank and borrow money on your signature.  Those days are long gone.  Loaning money is now a high stakes business, and they are no longer willing to bear all the risk themselves.  They want you to be risking something as well.

  1. Where to borrow
    1. Family and Friends – could be the easiest source, but it comes with lots of emotion.  You might find that your business is the primary topic of conversation at every family get together.
    2. Bank – Loans can be secured by real estate, or guaranteed by the government, as in an SBA loan, or backed by your personal assets, in a personal guarantee.
    3. Mezzanine debt – Higher interest loans from private lenders.  There are a lot of new “payday” loan kinds of companies.  They charge super high interest rates, and they skirt the banking laws by calling those fees instead of interest.  It’s hard to figure out how much interest you’re really paying.  Avoid these operations.  One quick way to identify them is if they are going to give you the money in 24 hours, and will do a direct draw from your bank account every day.  DON’T DO IT.
    4. Factoring – Borrowing money based on your accounts receivable.  They pay you for every invoice that you issue, within a few days, and they will then collect the money from your customer.  You get paid right away for your work, but you will also pay them interest on each check that they sent to you.  If you are short cash flow, this can be a good way of getting paid quickly, but it does cost you money.  Just be sure that you know the terms of your arrangement with them.
    5. Credit Cards – Credit card companies are ready sources of that Cash Advance.  Just be careful.  Interest rates are high, unless you have good credit, and are getting an Balance Transfer Advance.  You know, you get those letters from the bank all the time with generic checks attached.

  1. It takes time – Make sure that you have time to get the money.  Don’t expect to walk into the bank this morning and walk out with money this afternoon.  It can take 90 days or more to get your loan.  So be sure you plan for your cash future.

Borrowing money should never be done lightly.  Businesses use loans to cover temporary cash shortfalls, buy equipment, acquire companies, buy buildings or expand into new markets.  Loans should never be used to regularly cover operating shortfalls.  The most important thing to remember about borrowing money is that you will need to pay it back, so do it carefully.

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