9 Lies We Tell Ourselves About Loans

Getting a loan is not easy these days, and as a result too many entrepreneurs have given up even looking.  Instead we run around searching for all kinds of private equity and venture funding…  But if given a choice between a good old-fashioned loan and any other form of finance, I’ll pick loans every day.

Despite the economic doldrums, debt is still the best way to grow a business.  In fact, there’s really nothing better (or cheaper) than a loan.

So to convince you not to give up on loans, here’s my list of 9 Mind Blowing Lies About Loans and my 9 Myth Busting Reasons to Keep the Faith:

1. Debt is dangerous. This is the most common, most unfortunate mis-perception about borrowing money. In fact, a reasonable amount of debt can be a vital building block for a healthy and fast-growing business.  Debt provides leverage, which not only helps you accomplish more but also improves the financial return from your business. As the saying goes, it takes money to make money, and if you don’t have the cash to start with, borrowing it can be your best alternative.
2. Only banks make loans. In today’s economy there are more lenders than ever.  Wealthy individuals, called angel investors, are probably the most prolific lenders for small businesses, but various institutions are also stepping up to make the kinds of loans that banks can’t or won’t.  Corporate finance companies, private investment funds, even credit card processing companies are getting into the lending business.  There are as many flavors of loans as there are reasons to borrow.
3. Debt is Expensive. Actually, interest rates continue to be low by historical standards, and when you factor in the tax deduction for interest, debt may seem intoxicatingly cheap.  When compared to the alternative – say taking on an equity partner who owns 20% of everything – paying even a high rate of (tax deductible) interest, starts to sound attractive.  In any event, it is always best to measure the price of a loan against the return you expect to make on the money when you put it to use.  Borrow only when the rate of interest is lower than the rate of return.
4. One size fits all. There are so many credit card offers in the mail these days that it’s tempting to make plastic the panacea for all our finance problems.  But the most important rule of debt is this: different kinds of credit should be used for different kinds of expenses.  Just as a house is best financed with a 30-year mortgage, most business purchases should be matched with a loan of a size and term that roughly matches the size and term of what is being purchased. The best loans are custom tailored to the business need.
5. All loans require collateral. Not quite. Credit cards are the most obvious exception to this rule of thumb, but there are many others.  Often called “cash flow loans” many kinds of debt rely simply on a business’ ability to make payments from profits.  Sophisticated and reputable cash flow lenders will expect you to have a solid business plan and financial projections to show how the money will be paid back.  Of course, these loans are higher risk, so they typically carry a higher interest rate.
6. I don’t have any collateral. Sure, the least expensive loans generally do require some hard asset as collateral. But if you are committed to building and owning a business, dig around for the hidden assets in your life.  Many lenders are able to use Certificates of Deposit, stock accounts, cars, boats, and other personal assets (including your home, of course) as collateral for a business loan.  And don’t forget that the business assets you most need to purchase often make their own collateral.  Most equipment vendors, for example, will be able to recommend leasing companies to cover the up front cost of big-ticket items.
7. I’d have to put my house on the line. Almost every lender will ask for your personal guarantee on a small business loan, and often that guarantee includes pledging anything of value, including your home, car, and first-born son.  Don’t despair.  Set boundaries for yourself and your lenders, then negotiate loan terms that will let you sleep at night.  Everything is negotiable.
8. I can’t afford the payments. Loans that require interest only payments and “negative amortization loans” are just two examples of loans where payments are much smaller than you might expect. Be aware that each of these will be more expensive than traditional loans in the long run, but the smaller payments may be a good fit for a rapidly growing business.  Traditional loans can be made more affordable by negotiating a longer payback period or an adjustable rate that starts low and then “floats” as rates change.
9. As long as I make my payments, I’m ok. Don’t let the dark side of debt catch you off guard.  Larger loans from institutional lenders (like banks, or corporate finance companies) will include very specific loan terms, called covenants.  Loan covenants can require you to keep a certain amount of cash on hand, or to meet strict profitability targets. Breaking even just one covenant can cause the bank to demand immediate repayment of the entire loan amount. Negotiate carefully, and read the fine print.

Borrowing is never something to be taken lightly, so get the facts.  But knowing how loans work, and how they can work for you, is the first step to successful borrowing.

Committed to your (Leveraged) profits.

David

PS: Want to discover 27 things that you can use as collateral for a loan? Join as a member and get my free 27 page report, “Other People’s Money”.  Membership is free, and so is the report.  All you have to do is click the button to join!