As a business owner at some point you will be faced with the decision to either take on more debt or restructure the debt in place. Your sales might be growing or slowing but either way there exists an opportunity (perhaps need) to use debt to shore up your cash flow. Whether you choose to use debt to buy additional equipment or refinance existing inventory, this strategy done right can improve your bottom line and cash flow.
Too often, however, business owners view debt solely as a cost measured in terms of interest rate rather than capital to be invested to produce additional returns. The less debt the better, the lower the interest rate the better. Financing decisions are not unlike other business decisions; there can be more value to an option than just a low rate and sometimes the lowest price isn’t the best option.
The following are 3 examples of how business owners were faced with results vs rate decisions. Imagine you just hired a manager to run your business while you spend the next year on a fishing boat in Mexico – which of the following people do you want running the show? (these are based on actual cases, names were changed to protect pride)
Company A needs financing for a $80,000 truck to be added to its small fleet. The bank had already declined to finance as it typically does half the time or more. The Manager applies with Patron West but because financials are not up to date and the equipment is older the only lender approval obtained is willing to help at a 15% interest rate. The Managers thinks the rate is crazy. He exclaims “I will never pay those rates, the boss will fire me!” He’s upset, cancels the deal and doesn’t make the purchase.
If he would have accepted the financing and purchased the truck he would have generated an additional $5,000 – $7,000/month in net revenue to the business. Sticker shock and pride cost the business at least $60,000/year in profit! Also, this deal could have bolstered the balance sheet and helped the company get cheaper financing down the road. Doesn’t paying an extra $5,000 per year in interest to get $60,000 profit sound like a good result?
#2 Refinance Package
Company B wants to refinance $1,200,000 in equipment to consolidate some debt and put some cash back into the business for operating. Patron West obtained an approval at the bank with an interest rare of 6.0%. We also received an approval with an independent lender at 11.0%.
The answer seems obvious, take the 6.0% all day long, right? Not in this case. The Manager chose the 11.0% money because he didn’t want to be shackled by the bank’s GSA, reporting requirements, and financial tests as required by standard loan policy.
Turns out this choice saved the business when the market turned one year later. When other companies were having their loans called this client did not. An early payout allowance was structured so they could get out of the 11.0% money without penalty if needed. What did the higher rate get them? Control, security and predictability.
#3 Starting Up a New Business
There were two partners in Company C, an established business. The minority partner wanted to start up a NewCo contracting business. Newco had no credit, the owner had limited credit, and the majority partner of Company C was not willing to co-sign for the $100,000 financing.
Even without the guarantor and limited credit history, Patron West found a lender ready and willing to lend into Newco, however the rate was higher than he wanted to pay. The Newco owner had the contracts, staff, and experience to make this new business work, but kept stalling on the purchase and financing because he couldn’t accept that the rates were higher. Each week of delay cost him $15,000 in revenue. If he waited too long he might have lost the contract. The difference between what he thought he should get and what lenders were prepared to offer was an interest differential of $500/month.
Eventually the customer went ahead but only after nearly 3 weeks of delays trying to renegotiate the interest. The few thousand in interest savings cost him $30,000 in seasonal revenue. He signed the financing and now is running a very profitable business and reinforcing his value to prime contractor. Was the delay and stress over rate worth the savings?
All things equal, we aim for the lowest overall cost, but in business few things are rarely equal. What kind of business owner are you – are you focussed on the rate or the result? More concerned about your pride or your profit?