1st January 2010
Borrowing money is always attractive to the entrepreneur, because money today is particularly valuable for a growing business compared to tomorrow’s money, when the business is expected to be throwing off cash like Scrooge McDuck at a wedding. But it’s important to keep in mind that the debt investor’s profits are only the interest they receive, and they gain nothing from growth in the business. Because profits from lending money are reasonably modest – usually under 10% annually – they don’t want to be taking a chance on losing their investment outright.
For that reason, the debt investor will look at what the business has achieved in the past to decide if you’re likely to be able to repay in the future. As unfair as it may seem, past performance is considered to be the best indicator of future results, so as a rule of thumb, investors will look at net profits and compare it to the debt repayments to decide what the likelihood is of the business being able to afford the loan. If net profits (or more likely, EBITDA if you’re familiar with the term) are less than 1 times the required annual repayments, investors will be likely to expect increased compensation in the form of higher interest costs. If a lender is asking you for pay-day-loan style interest payments, then you have to stop and wonder why lenders consider your business so risky, and perhaps there’s a better way to raise funding.
Debt investment is also much more formula-based than equity investing – nearly every lender will have its “tick-box” criteria. In some cases it’s not even a matter of being a healthy business, but being the right business to fit into a lender’s loan criteria, so don’t take it personally if yours doesn’t fit into a lender’s criteria. It can be as simple as a particular lender wanting to diversify their portfolio, and they may consider themselves over-exposed to businesses very similar to yours. Brokers can be helpful when it comes to knowing where your business fits, but be prepared to pay potentially substantial fees if you involve a broker – and in many cases you may not even know you’re paying them as the broker may be paid by the lender, who will add the fees to your loan. Many brokers add little value aside from completing the application forms on your behalf, so consider whether this is a service you need if cost is a concern.
If your business has been trading for less than 2 years you will probably find it quite difficult to raise debt, as this is the cut-off for many of the biggest lenders. To address the need for funding with businesses who sit in the growth phase between start-ups raising equity and established businesses who qualify for debt, Crowd2Fund are currently trialling a new product, called the Revenue Loan. The minimum criteria is for the business to have been trading for at least six months and to be profitable, and rates start at 10% p/a. See the Crowd2Fund website for more details if you think this may be what you’re looking for.
There are a few things you can do to increase your chances of success when applying for a loan:
Author: Craig Snider - firstname.lastname@example.org
This article is also available on: https://thestartupmag.com/funding-business-securing-loan-funding
Past performance and forecasts are not reliable indicators of future results. Your capital invested is not covered for compensation in the event of a loss by the FSCS. Tax treatment will depend on the individual circumstances and may be subject to change. Please see our Risk section before making an investment decision.