Capital is a crucial part of running a business. Some are fortunate to have enough cash reserves from which to pull needed funds, but most have to use borrowed money until their business can produce sufficient revenue to sustain itself. This is common in business, but we must be mindful of the loans we take. There are loan terms that better our business and loans that bury our business. 

I receive countless business loan applications and solicitations. Some of them are reasonable, but most come with a noose attached. A few that I’ve seen would violate usury laws, which is excess of 36% interest, but because they are fee based, they escape through the loophole. There are also loans with lower interest rates, but require repayment in such a short amount of time, they could well be high interest also.

For example: A lender may offer you a $5,000.00 loan with a 10% fee, but impose a 6 month repayment term, with weekly payments. You’ll pay roughly $230 per week until the loan is repaid. That’s nearly $1,000.00 per month. You may ultimately find yourself in a worse financial situation than you were in prior to taking the loan.

Another predatory loan type are the ones that take a percentage of each sale. Initially it sounds good, until you realize that they’re taking upwards of 30% of each sale. Sure the interest rate or fee might be low, but 30% off each sale can be devastating for a business. It ruins your cash flow and you could end up repaying the entire loan back within three months or less.

Why is this an issue? The problem isn’t that you’ll repay the loan quickly; the problem is the rate at which you’ll repay the loan. Let’s say the rate is 10%, which seems low for an unsecured loan. However, when you factor in that the loan is repaid in three months, the real annual rate is closer to 40%.  

If you think the above two are bad, I recently reviewed a loan that required daily payments for 60 days. They would generate a 50% profit within 60 days. This sort of capital is extremely expensive. They aren’t structured to help you win the day, so just say no!

A good loan should better your business. The terms should be such that you see an offsetting or greater rate of return from the loan. If you’re purchasing inventory for resale, the revenues generated from the sale of those goods should be sufficient to cover your cost of goods sold, your loan payments, enough to pay yourself and hopefully turn a profit. If the loan will not accomplish this end, you should consider walking away.

If you’re borrowing funds simply to pay bills, then you have no way of making a return from the loan, especially if those bills are ongoing. Unless you have a plan by which you’ll generate more revenue, the loan will only worsen your situation. You’ll have the same bills you had prior, but with a new loan payment added to it.  

Desperation is the mother of good and bad deals, depending on which size you’re on at the time. I’m a realist. I get it! Sometimes a loan is the only means by which we can keep moving forward. This is a factor on which predatory lenders depend.

Rather than bury your business and possibly yourself, get creative! Seek out other avenues by which you might raise the needed capital. Ask other business owners what they’ve done in similar situations. Consider bringing on a business partner. All money isn’t good money. Make sure any loan you take is a win for you and your business!

Written by: 

Eric L. Lipsey | Founder | Owner 

VENTRE Capital, Inc.

www.VentreCapital.com