What kind of money do you need?
It’s not a ‘Trick Question’
When you need to negotiate for a business loan, it’s important to understand that there are three basic "kinds" money to borrow: short term financing, term money and equity capital. While the purpose of the loan is one of the most important factors in deciding just what kind of money you are actually looking to borrow, it can still be a bit tricky deciding which sort of capital will best meet your needs on terms you can live with. To make matters even more complicated, there are also times when properly funding a business means using all three of these basic kinds of loans at the same time – and for more or less the same purpose. Key to making the decision – in addition to what terms your lender is willing to offer – is understanding the important distinctions between the repayment terms that accrue with each sort of loan.
Short Term Loans
Generally speaking, short term loans are repaid from the liquidation of the current assets that they have furnished the money for. In other words, you borrow money to finance an inventory. You sell the inventory in a given period of time and you repay the loan from the proceeds.
Long Term Loans
Long term loans, on the other hand, are repaid through earnings that accrue as your business grows with your ability to maintain the terms of the debt repayment.
Banks and other lenders are getting more careful with lending money these days, but typically, both short term and long term loans are given on the basis of a borrower’s general creditworthiness and recognized ability to repay the loan. Often, these are unsecured – meaning that no collateral is put up against the loan.
On the other hand, a secured loan (like a Home equity line) relies on a personal pledge of all or some of your assets.
Equity Capital
Equity capital works differently. On the plus side, you don’t have to repay the loan at all. But before you start to think that there really is a "free lunch," you need to understand that - with equity capital - you are, in effect, selling away a portion of your business. In simple terms, the people who invest equity capital in your business now own part of your operation and they expect to make their money back via your future profits…like buying stock in a company.
How Much Money Is Enough Money?
So you’ve come to the inescapable fact that you need to infuse some money into your business and are comfortable you know and understand what kind of money you need – and are willing to negotiate for. The other part of the issue is "how much do you need?"
It’s not as easy a question as you might think. Largely, the answer depends upon why you need the money in the first place. Are you building a new facility? Expanding a current one? Buying new equipment? Starting a new business? Or deep in the hole from a bad step or slowing economy? Each of these situations carry with them different lending requirements from lenders – which mean different kinds of terms for you.
Knowing what option you actually have can help you make the best decision regarding what you actually need to borrow to keep going …and on what terms.
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