Beware of the Wolf in Sheep’s Clothing
One of the biggest nuts to crack when you start a new business is working capital. I’ve been down this road a few times and have learned that seeking a “working capital” loan can be very expensive. It can also do more harm than good—if you’re not careful.
There are many different types of loans. Some are secured (collateralized) and others are unsecured (uncollateralized). Then there are fixed and variable rates, as well as different length terms. In this article, we’ll focus on unsecured debt that’s borrowed for the longest term you can get. If you have no credit or bad credit, that term will be about 9 months.
Let’s suppose your business has borrowed $14,500 of uncollateralized debt. The term is 6 months with daily payments of $185. The lender is willing to lend an additional $7,000 if you make all payments on time for the first 3 months. Your payments for the remainder of the combined loan (another 6 months) will be almost $375 per day with a complete term of 9 months.
According to these numbers, you will have received $21,500 and within 9 months will have paid back $32,069. A rough calculation shows that the loan’s simple interest rate is approximately 45%. This begs the question: How much can you achieve with $21,500 in 9 months? Unless you can earn approximately 85% ROI (return on investment) on the funds you borrow in 9 months, you’ll end up paying back more than you borrow. Does that work for your business? Are you willing to roll the dice?
These loans are called uncollateralized SBA loans, bank loans, or merchant advances. They can cost you a lot, especially if you’re a startup. They are the wolves in sheep’s clothing.
If and when the time comes to borrow, you must accurately calculate your needs and actual all-in costs. Never bite off more than you can chew! Consider hiring professionals to help you navigate your finances and ensure you take only calculated risks.
OnPoint Partners is here to help. Our experts can perform a free, one-time financial analysis, empowering you to make educated decisions as you grow your business.