Small and growing businesses are invariably undercapitalized and will need to borrow funds at sometime. Debt financing creates financial leverage for the business owner that can be rewarding as the business prospers. Financial leverage is the borrowing of funds and investing them in your business at a higher rate of return than the cost of the borrowing.
Banks and commercial finance companies are the two most common sources of borrowed funds for the small business. Let’s put the process in a perspective that is familiar to the business person.
The business owner is constantly buying products and works with a number of different suppliers on a daily basis. When it comes to money and banking however, it is often an infrequent and possibly intimidating experience. Let’s consider the money we need to borrow the same as any other product that we buy and let’s look at our bank the same as we do our other suppliers.
If money is a product like any of our other supplies, we should be sure that we have enough to meet our needs, but not so much that our “inventory” carrying costs will be high. We should insure that we use it efficiently because the excess use of any supply item or raw material will increase costs and decrease profitability. As with all purchased products, we should shop before we buy. There is a competitive market for most all of the products and services we use in our businesses and that includes the money we need to borrow.
If money can be viewed as a supplied product, then our banker can be looked at by the same standards as our other important suppliers. When you evaluate your other suppliers, price is not the only criterion for comparison. Service, delivery, quality and the ability to accommodate the special needs of your business are factors that you consider. These same standards should be used when you are choosing and comparing banks.
Now that you are ready to look for a business loan, where should you start? What should you be looking for and what can you expect to find?
The best place to start is with a financial institution where you have established relationships. Good business relationships are a most important of doing business. Business relationships aren’t really between business but rather between the people that own and manage the businesses. So if you currently have a business bank, start there. If you are just staring a business, begin with the bank that you use for your personal banking. If your current bank isn’t equipped for the type of business loan you need, they will be able to give you a personal introduction to one that can.
At the Monterey County Bank, they view their relationships with their customers as partnerships. They recommend that you make sure that your banker understands your business. If your banker is not trying to learn your business, you might have the wrong bank. Both you and your banker should be working together to insure that the bank knows and understands your business.
Three frequently used borrowing arrangements are lines of credit, term loans and working capital loans for accounts receivable and inventory. With a line of credit, a bank is extending a commitment to loan up to a specific amount under certain prearranged terms. The borrower draws on the funds as needed and pays interest only on the outstanding balance. The borrower is sometimes required to pay an initial commitment fee based on the entire amount of the loan .
Term loans are business loans with a fixed maturity, usually not more than seven years. Term loans are used for a variety of purposes from equipment financing to business expansion. They generally have a variable interest rate and are often secured by the assets acquired.
The financing of accounts receivable and inventory are probably the most common reasons for business owners to borrow. Once this was primarily an area for the commercial finance companies, but now it is an active area for all full service banks as well. Typically an agreement will be structured that will allow the borrower to assign the assets to the financial institution as security for loans that can generally range up to eighty percent of the value of the receivables and to fifty percent of the value of inventory. This can most often be accomplished without any involvement or notification to the customers that actually owe the money.
When looking for a business loan, your most most important decision is choosing your “supplier”. Anticipate your need to borrow as you would the need for any product. Begin with those that you know and shop wisely. Look to establishing the type of long term relationship you would have with any of your important suppliers. A good supplier of debt financing will help you choose the right product. Because “It’s Your Business”, the right product will let you benefit from the increased financial leverage.