- Written by webmin
- Published: 14 Sep 2010
Many small-business owners know that they need a loan, but they might not know what type of loan they need. Like businesses, all loans are not created equal, and going after the right loan not only increases the odds that you’ll qualify for that loan; it ensures that you’ll be able to pay it back.
Loans are a lot like marriages — the right one will meet your needs and keep both parties happy. But a bad one can be costly and will most likely end very badly. So before rushing into one (a loan or a marriage), make sure that you’ve reviewed your options and understand what your responsibilities are going to be.
Lesson No. 1 – Matching Your Purpose with Your Needs
Greg: To know what kind of loan your business needs, the first thing you need to look at is the purpose. When a loan goes bad, it’s often because the purpose was bad.
For example, if a company needs to borrow to meet payroll that means it isn’t making enough money. That is a loan with a bad purpose.
Ron: You also have to look at the maturity of the loan. If the purpose is a short-term need, it should have a short-term maturity. If it’s a long-term need, it should have a long-term maturity.
Greg: Yes, you really have to marry those two things together.
Ron: People will often tie up their cash, and then they aren’t able to use it to grow their business. Maybe they have $100,000 in cash and they decide to take that money and add on to their building.
Now, the building is a long-term asset. It doesn’t make money overnight; it makes a little bit each month. So they spend their money on the building and then the next month, they don’t have any money to buy more widgets. That means they can’t sell more widgets. Now they don’t have any working capital to do what they need to do. They have a big building, but they don’t have any liquidity.
What they need to do in this case is borrow the money to build on to their building, which is a long-term asset, and because it is a long-term asset, they should finance the addition with a long-term loan, meaning a 10-year loan. Then they can keep the $100,000 to buy short-term assets and handle the cycles of their business.
Greg: Another good example I’ve seen is where a company goes out and buys a new fleet of trucks. It invests all its money in these trucks and now all of a sudden it can’t make payroll. So it has a great fleet, but it can’t pay its drivers.
Ron: The owners should have borrowed on terms that reflected the expected life of the asset. If they plan on replacing the trucks every three years, it should be a three-year loan. That’s a good way to gauge what the term of your loan should be.
Real Estate Loans: Grounds for Business
Real estate loans prove to be a tricky area for many businesses. While they can be a valuable investment for a company that needs to own its own space, the speculative real estate market has been the downfall of many an entrepreneur.
Greg cautions against real estate loans for the businessperson who is interested in building spaces such as shopping centers or warehouses. While they may seem like a cash cow, the fact is that you’ll have to find tenants to make them profitable. Ron has made most of his money over the last 10 years building and renting out such buildings. But he is experienced, and is a great marketer. Make sure you understand all that is required in skills and experience.