Imagine you purchased a new event rental business in February 2020. When you did it, you chose to finance the business with a five-year note instead of a 10-year note. You didn’t like the idea of having debt, so you wanted to get it over with as soon as possible. You decided to stomach the bigger monthly payments, even though it would make cash flow tight.
Then the unexpected happened: Coronavirus (COVID-19) hit, and your business was forced to close for several months. Once you were allowed to reopen, no one was holding large events anymore. For the foreseeable future, your business had been changed in unimaginable ways. Now, you are wishing you had chosen to finance the business over 10 years instead of five. While I use the example of a business acquisition, this information is important for all business owners who have, or are considering, taking on debt. Always make sure you understand the terms and conditions before signing on the dotted line. Debt is an amazing tool for business owners who are looking to grow their business, as long as they utilize it correctly. Give yourself a comfortable monthly margin in case of emergencies.
Financing strategy always is about playing offense and defense. That’s why I often encourage entrepreneurs to think about using the U.S. Small Business Administration (SBA) to buy themselves the flexibility of 10-year money, especially when any SBA loan under 15 years has no pre-payment penalty. This means that if times are great and money is flowing, you could pay off the SBA loan in five years. Or, if a crisis hits and cash flow is tight, your monthly payment is still lower since it’s based off a longer term.
The next question I always get is: “What about the interest rate?” To this I always answer: “Don’t be so interest-rate sensitive.” Now, this doesn’t mean you shouldn’t be on the lookout for those outrageously high interest rates you see with some online short-term lenders. But, when it comes down to 4 percent on a five-year bank loan and 6 percent on a 10-year SBA loan, don’t automatically assume the loan with the lower interest rate will be better for you. Having the lower monthly payments will come in handy, not if, but when, your business faces challenges in the future.
For example, an entrepreneur who received an Economic Injury Disaster Loan (EIDL) two months ago was considering paying the loan back. She felt that her business has mostly recovered, and she didn’t like the idea of having the responsibility of paying back a loan. My advice for her? Not so fast.
In a period of uncertainty, possession is 99 percent of the law. Her EIDL loan is due over 30 years, at a nominal interest rate. The monthly payments have no severe impact on her cash flow. In my opinion, she could consider the payments like an insurance premium, and hold on to the cash. That does not mean she should use the money frivolously, but there is little reason to not hold onto it.
Remember that financing strategy is a combination of offense and defense. You want to be situated to take advantage of unexpected opportunities and deal with surprises you weren’t anticipating. This philosophy is more real than ever in these uncertain times and plays a huge role in thinking long, not short.
Ami Kassar is the founder and CEO of MultiFunding, a Philadelphia-based consulting firm that specializes in helping business owners across the U.S. develop creative, cost-saving alternatives for their business debt needs and structure. He can be reached at firstname.lastname@example.org or multifunding.com.