Thursday, August 11, 2011

To Borrow or Not to Borrow

I'm taking issue with a quote from the article: "7 Financial Mistakes to Avoid":
"Just because a bank is willing to lend you money does not mean you should accept it. The bank is in business to collect interest and not to optimize your financial performance. Sometimes these two goals meet somewhere near the middle, but it is not as often as you might think. It's not that bankers seek to take advantage of businesspeople; it's only that their objectives and yours are very different. In general, borrow as much as you need to grow your business. The problem with credit is not that there is too little available; it is that people get too much of it. Borrowing money adds a huge burden to your business, a stress that can often cascade into your personal life." (The bold is my emphasis.)

Okay, I like this statement even though I disagree with a lot of it. It got me to thinking and inspired me to debate it. Admittedly, I wholeheartedly agree with "borrow as much as you need to grow your business".

When you are highly profitable (i.e., profit margins of 10% or more) and have an excellent personal credit history or a very strong business credit history, you have or can obtain access to a lot of bank credit. Sure, if you are venture-backed or backed by a deep-pocketed angel or strategic investor, you'll also have acess to a lot of bank credit. But the vast majority of small and medium business owners are NOT in this predicament. So go for the money while you can, if it makes business sense.

Remember how Ford weathered the automotive industry downturn? Sure, it had a stronger strategic and operational vision than GM and Chrysler but it also saw a credit tightening in its future. Consequently, Ford's financial team identified and utilized a few specific sources of debt financing to fill its coffers in cash in advance of the credit restrictive environment it foresaw. This gave Ford access to cash at a time when many of the large banks were in trouble themselves and so most certainly weren't lending and other sources of debt financing that large corporations typically have access to had nearly dried up. If Ford hadn't taken advantage of the access to credit when it did, it would have had to pursue less available debt capital at significantly higher interest rates which would have adversely impacted its financial statements.

So obtaining a bank loan when your company is highly profitable but intends to spend significantly on human capital, infrastructure, or other expenses in the future (next weveral months to few years) to support the growth of your business is good. Why? You can place the funds in a CD, treasury bonds, marketable securities or something else that will reduce the effective (net) interest rate on that capital, then only spend the money as the strategic plan and market suggests. The capital expenditures will somewhat depress your financial statements, making you less attractive to a bank, raising your interest rates. But since you, like Ford, accessed the money when you were healthiest (from a bank's perspective), you don't need to worry because you do not need to borrow any more money for a while. Put another way, getting a bank loan to support future growth is like pulling cash out of your house in 2007 to pay for your high school sophomore's college education or as additional capital for a business you've been building from home.

However, obtaining bank loans and using them unwisely is never good. You have to look beyond the current situation to the anticipated future situation...while factoring in best case and worst case scenarios. Otherwise, obtaining a business bank loan that you end up using unwisely is just like pulling cash out of your house in 2007 and using it to fund vacations, cars, etc. It seemed like a good idea at the time but you were thinking far too short term and the changes over the next two years slammed you.

If you are uncertain about what you should do if you have access to credit now but aren't sure if you should pursue that credit or not, another alternative is to obtain a line of credit from a bank. You only pay the fees on the bank line of credit. You do not have to make interest payments until you actually draw down on the credit line.

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