When most entrepreneurs begin the process of seeking a business loan, one of the first concerns that occupy their thoughts is the price of the loan – namely the interest rate they will be charged.
As you already know, just getting a lender to consider your business loan request is hard enough these days – but, to get one to provide your business capital at a rate that you feel is the most beneficial to your operations is down right impossible.
Every day I get requests from entrepreneurs (start-up or established business owners) who want to know where they can get a cheap business loan.
My answer is always the same – define cheap.
No loan is cheap but on the other side no loan is expensive either – if it is put to proper use.
The difference between a few percentage points on a loan is no where near as meaningful as what is done with the loan proceeds. Business loans are meant to be a leveraging asset – meaning that you leverage current cash flow to obtain a loan then use that loan to generate more in new revenue than the loan costs.
Thus, a loan is only an asset to be used by a business in its operation or quest to generate more income and wealth.
Let’s take a simple example:
You and another local competitor have identified a market niche that could potentially create new uses for your current products. While this market is yet unproven, you both believe that it has tremendous potential.
You go to your lender seeking a business loan for $100, 000 for three years. The lender agrees and quotes a rate of 10%; making your monthly loan payment approximately $3, 227.
You feel that this rate is too high given the long relationship you have had with this lender and all the money you have paid to them over the years. Plus, you spent a few hours online researching that the average business loan rate is around 8%.
Your lender states that he might be able to get your rate reduced to 8% but you will have to wait until their next loan committee in two weeks to get it approved.
At 8%, you monthly loan amount would be approximately $3, 134 – a $93 per month savings or $3, 351 over the life of the loan over the 10% rate for the same amount.
In the mean time, your competitor goes to the same lender and receives a loan quote for the same amount at the 10% rate. Your competitor takes the deal.
By the time the loan committee approves your 8% rate – your competitor has already executed its marketing plan for this new market, has created demand for its products and is now generating an additional $10, 000 per month in new revenue from this niche.
Once your loan is funded, you attempt to execute your marketing plan but find that you are a bit too late and your business is only able to generate $4, 000 per month in additional revenue (your product is seen as a copy cat to the new market leader – your competitor).
While this new revenue pays for the loan – the new revenue generated for your business is still some $6, 000 per month lower than your competitor.
Let’s look at the difference. Over three years, the total amount that you have to repay for the loan is $112, 811 ($3, 134 times 36 months). Your business brings in $4, 000 per month for those same 36 months and you earn $144, 000 with a net profit of $31, 189.
Your competitor spends more on his loan – $116. 162 – but earns some $360, 000 or net profits of $243, 838 or 782% more than your business all because you wanted a cheap loan.
The bottom line here is that the cost of the loan really did not matter here. The price that your business paid for not getting into this niche before your competitor is much higher (a loss of some $6, 000 per month in revenue) then the $93 per month you saved.
If you compare his rate of 10% to the profit he made of some $6, 773 per month ($10, 000 – the monthly payment) – his loan really was the cheaper one.
And, it really doesn’t matter if you actually had a competitor trying to beat you to the market. There is an opportunity cost of not taking a business loan or by not getting it when the time is right.
Even if you were just delayed a few weeks while fighting for a lower rate – the amount of income that you lose by waiting (an amount that you can never make up as time does not go backwards) would exceed the amount you were trying to save – in this case, (if you did not have a competitor beat you to the niche) waiting two weeks would cost about $5, 000 in new revenue while you were only getting a savings of $3, 351 at the lower interest rate.