Sometimes You Need More Expensive Financing

You have to weigh all of your options to make the best financing decision.

Price-shopping is something that nearly everyone does at some point in their lives.

Whether it’s parents stretching their household budget, kids trying to make their allowance last or multi-national conglomerates trying to get the best possible deals from suppliers, it all comes down to the best deal. Consumer and business advocates constantly harp on the importance of getting the most for your money.

That’s usually sound advice.

But when it comes to businesses in need of financing, the interest rate, while important, shouldn’t be the end-all, be-all factor.

Consider this example.

A company that generates about $25 million annually in revenue has a bad year. That prompts the bank to call the owner’s 5 percent line of credit.

The owner then rejects his financial adviser’s suggestion to secure an 8 percent asset-based line of credit from a different lender. The owner says he doesn’t want the added $150,000 annual expense the more expensive credit would create.

For the time being, the business owner is stretching out payments to his vendors, which certainly isn’t engendering good feelings.

Meantime, he’s looking into the possibility of selling equity in his company for the first time.

What are the risks to this approach?

For one thing, messing with vendors is a perilous proposition. Getting cut off is a real possibility — and that creates numerous other potential problems that can threaten the viability of the business.

And then there’s the issue of taking on partners by selling equity.

Sure, the infusion of cash is nice (as is not having new debt), and if you lose money or go under, the investors, having understood the risk, may not have to be repaid.

The flip side is that those new partners will be around forever.

What happens if you and those partners disagree on the company’s direction? There are numerous cases of that occurring — and there have been multiple instances where the original owner was forced out of the company.

Even if things don’t deteriorate to that extent, your agreement with your partners might require periodic dividend distributions to shareholders. Because small and mid-sized business in growth phases often want to reinvest all profits back into the company, those dividends could severely limit your growth potential. That’s clearly less than ideal.

Whether you choice to sell equity is up to you — and given the right investors it can work out fine — but you should strongly consider the idea of debt with a higher interest rate.

Sometimes you simply have to pay the piper for a while. It’s unfortunate and unpleasant, but it’s not the end of the world.

If you truly believe your business plan is sound and your future prospects are bright, the higher interest rate ultimately gives you added flexibility. Should you return to your usual level of profitability (or even a higher one) and enjoy strong growth, the chances are good you’ll be able to find new funding at a rate comparable to — or even better than — what you had before.

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The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.

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