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When to Raise Capital (Part 1 – When To Raise Debt)

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-Brandon Hinkle/

There’s a popular saying in banking that it’s always best to request a bank loan when you don’t need it.  And there’s a popular saying in entrepreneurial circles that a banker is one who gives you an umbrella when it’s sunny outside, and takes the umbrella away when it’s raining.  Either way, you should always seek money before you need it.  This is particularly true for debt financing.

When To Raise Debt For Your Business

If you foresee a need for cash in the future, and if you can prove your company has the ability to quickly repay a loan (plus interest), than you should start seeking a bank loan.

  • Criteria: See What banks look for in a business loan to better understand the bank requirements for debt, but suffice to say the bank needs to know your business has the wherewithal to repay a loan on time, plus interest.  You usually also need to put at least 20% of your own capital into the project being financed.
  • Favorable attributes of debt:
    • The ability to put other people’s money at risk (instead of your own) without giving up ownership.  Private equity folks get rich with this strategy.  Warning: too much debt can strangle a company.
    • Over the long term, debt is cheaper than equity (if you believe your business has meaningful value).
    • Loan interest (expense) can reduce the company’s taxable income.
    • Debt forces financial discipline; it’s harder to make risky investments when the company has loan payments to make each month.
  • $ Cost of debt: A traditional bank loan generally charges 5%-7% annual interest.   Sometimes the interest rate is variable, sometimes it’s fixed.  Fees generally range from 0% to 3% of the loan amount, depending on the bank and loan type.
  • Hidden cost of debt: 
    • Increased risk of bankruptcy.  Your cash flow might get a temporary boost from the loan, but be careful not to borrow too much money; otherwise, every cent your business generates will need to go towards debt payments, strangling the company’s cash flow.  If your business experiences any unfavorable surprises you might not be able to make the required debt payments, which could lead to bankruptcy.
    • Debt requires more financial discipline and cash management than equity because of the amortization schedule and loan covenants associated with debt.
    • Beware of vulture lenders.  The difference between 7% monthly interest and 7% annual interest is enormous.  7% monthly interest is equal to 84% annual interest.  No reputable lender speaks in terms of “monthly” interest rates.  Read the fine print and confirm that the interest rate being charged is the ANNUAL interest rate.  Avoid opportunistic vulture lenders at all costs.
  •   How to find the right bank for you:
    • (shameless plug) is a free online tool available to small business owners seeking to get matched with appropriate, reputable lenders to find the best possible rates.
    • Consult with your local Small Business Development Center.
    • Apply for a loan in person to 5-6 banks, including a few large national banks and a few small community banks.  Cast a wide net and don’t settle for the first offer that comes along!
“Part 2 – When To Raise Equity” coming soon!

Brandon Hinkle is the CEO of  Prior to plura, Brandon served in the workout group for GE Capital’s sponsor finance division (Antares), and was an underwriter in Merrill Lynch Capital’s corporate finance group. He started his career as an underwriter in Merrill’s small business lending division. Brandon has a BA from Michigan State and an MBA from Northwestern University. Contact Brandon directly


Written by entrabanker

June 7, 2012 at 9:35 pm

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