The complexities of operating a business can leave you scratching your head. As ideas churn in your mind for new equipment, business expansion or hiring more employees, the bottom line is always: How will you pay for it? 

If cash is short, a low-interest business loan may be the way to go. While many small businesses are averse to debt, being debt-free actually can restrict business growth or even cause a business to collapse. Without the necessary funds, a business will remain at a standstill or fold. The old adage “you need to spend money to make money” rings true. 

Even businesses that never took out a loan before may want to apply for financing now because interest rates are historically low. Rates are expected to remain low for years, as the country recovers from a pandemic-induced economic downturn. Despite the uncertain economy, now may be a good time to take out a loan. There are many good reasons to apply for a business loan, but that doesn’t mean you should rush out and apply without carefully considering your options. 

“Be really sure you need the loan,” advises Dave Kaster, principal at Fidelis LLC, a business advisory practice in Green Bay, Wisconsin. “Unless you’re in a very stable business with a regular type of income, you have to think harder about getting a loan.”

Savvy business owners don’t go into debt for just any reason. They have a clear vision of how to successfully grow their business. Focusing on this vision, they’re willing to step out of their comfort zone and pursue financing options.

“If you decide you are willing to take the risk, contact your SBA (U.S. Small Business Administration) rep and see what your options are. Then, go to a banker that you feel you have the best relationship with and start talking,” Kaster says.

Dig into plans for the loan and how you’ll pay it back. Be honest with yourself and your ability to repay the loan. Ask questions like: What happens if I miss a payment? What happens if I can’t pay off the loan when the time comes? Know the answers to these questions before you sign.

WEIGH YOUR RISK

Once you understand the terms and conditions of a loan, consult with someone you depend on for business advice — an accountant, business advisor, spouse or colleague. Lastly, make sure your business plan syncs with the requirements of the new loan. A solid business plan includes carefully prepared financial projections, budgets and cost analyses. Lenders will look at your operational methods to project the rate of return on their investment. 

To measure the risk of taking out a loan, consider how you will repay it. For example, you may decide to borrow money for equipment. Consequently, the equipment you purchase becomes a fixed asset.  

“The loan on that fixed asset becomes a fixed cost. You have to pay that every single month,” Kaster says. Before you invest in the equipment, estimate the income you’ll earn by using the equipment.

“Can the money that fixed asset generates make the payments for you?” Kaster says.

In addition to purchasing equipment, you also may decide to expand through acquisition. Business acquisition can breathe new life into an organization, but comes with some challenges. When businesses expand, cash can get tight. Taking out a loan will only defer the problem of tight cash until the loan has to be repaid. In this scenario, Kaster tells business owners to plan ahead.

“Make sure that your operations and your marketing plan are lined up in such a way that you’ll start getting the income you need to pay off that loan. If you’re adding a new territory or acquiring a business, it’s going to take a while before you’ll see the cash flow off of that business.”

DUCKS IN A ROW

Cash flow is an issue that businesses deal with every day. A high-level business plan can help you determine how much cash you need and what you can afford to repay, says Aaron Faulkner, senior vice president at Bank First, Green Bay. He offers a number of tips geared to business owners considering applying for commercial lending. 

First, he encourages owners to have their personal finances in order. You may think your business credit and personal credit are two separate things, but they’re not. Commercial lenders often base their decisions on how individuals handle personal finances. A solid credit history shows you paid your bills in the past and are likely to pay your bills in the future. Lenders evaluate you as a business owner to project how you’ll handle your business finances, especially during the tough times.

Next, businesses should be ready to contribute equity. Lenders don’t want to be the only player in a business venture. For example, if you want to borrow $100,000, a lender may ask you to contribute $20,000 to $25,000 of cash, equity in your home, a gift from your family, or a combination of these. Showing a capacity to contribute equity is important because it signals that you are committed to the project. 

Likewise, a commercial lender commonly will ask you to pledge collateral to cover your financial obligations if there’s a shortfall. Collateral could be the assets in your home, a personal vehicle, vacation property, investment accounts or cash. Be aware that personal and business assets are closely related for small businesses. When you obtain a commercial loan, you sign a personal guarantee. When the loan comes due, the lender isn’t simply looking at the business for repayment, it’s looking at the owner, too. If the business can’t repay the loan, the business owner will be held responsible instead.

Lastly, if you’re purchasing property, make sure you understand commercial mortgages. A commercial mortgage is different from a home mortgage. Commercial mortgages have shorter amortization, closer to 20-25 years, not 30 years. Typically, commercial mortgages are three- to seven-year notes that end with a balloon payment. In most cases, a business can renegotiate the loan when it comes due, if the business doesn’t have the funds to pay it off. 

EQUITY OPTIONS

Compared to residential mortgages, commercial mortgages usually have a higher down payment. The minimum down payment will probably be 10%. Sometimes, the financial institution will lend you that 10% from a home equity loan or some other capital you have. 

Additionally, lenders work with municipalities and the property sellers to carry some of the debt as well. Equity doesn’t have to come exclusively from the buyer; sometimes it comes from other sources. A trusted lender can walk you through the various scenarios.

There are many things to consider regarding commercial lending. Looking at the big picture, the question isn’t just “Should I take out a loan?” Instead, ask yourself, “How will I repay the loan?” and “What will I use the money for?”  

Will you purchase a truck or equipment? Buy out a competitor? Construct, buy or lease a building to expand your territory? Hire more employees? Of course, one big question mark is the COVID-19 pandemic and how it will affect your business.

“With economic times being somewhat uncertain with the pandemic, consulting your banker can be a huge value add,” Faulkner says. “Many government programs are offering reduced or no fees, as well as offering assistance with making payments for several months on loans. This, coupled with a low interest rate environment, is certainly a reason to connect with your bank to see what type of options are available.”