Importance of Borrowing

Benjamin Franklin once said, "To understand the value of money, go and try to borrow some." For some small businesses and corporations, this is a difficult lesson to learn. Nevertheless, business borrowing is a vital part of successfully running a company, and all business owners should learn this lesson in order to understand how to borrow more effectively.

Even though your word may be your bond, a positive business credit rating is crucial to borrowing money on good terms. No business can build business credit or secure needed funding simply by promising to repay it. Business lending institutions will evaluate certain standards in order to determine whether or not they will lend to your business.

This chapter will explain many of the reasons why you may need to borrow money as your business evolves. Primarily it will discuss the credit analysis method of the Five C's which commercial lenders rely on to assess corporate credit worthiness. This chapter will also analyze the lending opportunities larger companies often take advantage of and factor in the obstacles that often face smaller companies.

Why Should You Borrow Money for Your Business?

Unless you are lucky enough to have just won the lottery or have an enormous private trust fund, it is likely that you will need to look beyond your own private funds to finance the establishment and expansion of a business.

You could patiently wait to save enough funds required in order to support the growth of your business, but this will stall your business plans considerably. For instance, if you saved $1,000 a month in an account that paid you 5% interest, it would take you nearly seven years to save $100,000.

Or you could try to find investors to finance your business by becoming your partners. In situations where an individual will bring more than just money to the partnership, such as knowledge of the industry, contacts, or other characteristics may be helpful to the development of the business. However, when securing needed funding is the only benefit to the deal, bringing in additional partners may not be desirable. When making a decision like this, it is important to weigh the impact of diminished ownership and decision-making during the time that the investor has a vested interest in your business.

On the other hand, you can maintain autonomy and expedite the growth of your company if you don't wait to save money or add partners. When it comes to financing your business, there are many good reasons why borrowing money makes sense:

• Obtaining Assets – This means purchasing needed equipment or real property in order for your business to run effectively. By securing a business loan, instead of leasing needed items, you can buy them. You may also have the opportunity to purchase the facility that you operate from, for example an office/medical building, storefront, warehouse, or factory.
• Replacing Existing Financing – This means upgrading the terms of any existing debt by replacing it with improved financing options. For example, you may have taken out a loan when your business was just starting out and you had not yet established a positive credit profile. However, once you build business credit, you are able to take advantage of more favorable terms for your financing, including releasing any ties to collateral, reducing interest rates, or eliminating other terms of the loan by securing funding from a new lender.
• Acquiring Equity – When a business has multiple owners, whenever one of the owners leaves the company, the remaining owners typically acquire the departing owner's "equity" or share of the company. Depending on the size of the company and the ownership interest at stake, commercial lending may be required to finance the purchase.
• Working Capital – Many businesses face cash flow challenges, whether it be from seasonal highs and lows, unforeseen circumstances such as uninsured losses, or slow revenue from accounts payable. At times like these, if you establish business credit then you will have access needed funding to take care of necessary financial obligations.

Size Matters

The size of a company is an important factor when it comes to applying for business or corporate credit. Large companies and corporations can access funding in many ways that are not available to smaller companies, including:

• Public Offerings – Public corporations can raise funds by offering ownership in their businesses through the sales of stocks and bonds.
• Commercial Funding – Most commercial financial institutions are more likely to loan to larger companies and corporations than to small companies. Since the process involved to loan a large amount of money is basically the same as what is required to lend a small amount of money, it is simply more profitable for a lender to issue larger loan amounts than smaller ones. Because they are the most coveted borrowers, large companies also have more flexibility when borrowing capital when the economy is uncertain and other lending opportunities become more stringent or disappear. At times like these, small businesses often have a very difficult time qualifying for loans from these types of lenders.
• Favorable Lending Terms – Unlike small businesses, large businesses and corporations traditionally qualify for the most lenient loan programs, including those with the lowest interest rates. According to the U.S. Small Business Administration (SBA), in November 2003 large corporate borrowers with the lowest risk were charged only 5.5% interest on fixed-rate loans whereas small businesses (borrowing microloans of less than $100,000) were charged 6.53%.

In the end, small and medium-sized businesses and corporations have a more difficult time qualifying for commercial lending programs. According to the November 2005 report from the Office of Advocacy of the SBA, in recent years access to small loans (less than $1,000,000) and microloans (less than $100,000) has continued to decline while the total dollars borrowed through larger loans has continued to increase.

As a result of the difficulty in qualifying for traditional bank loans, smaller businesses and corporations often seek out alternative, more costly financing opportunities. Credit card borrowing, finance company loans, and private lender loans are all alternatives that small business resort to in order to secure needed funding when commercial loan programs are not available to them.

But this does not mean that small companies and corporations have to rely solely on high-interest, costly funding opportunities. By increasing creditworthiness, small business owners can benefit from even greater access to affordable financing options.

Summary

No matter what stage of growth your business is in, there are many reasons to consider borrowing funds that will help you achieve your business objectives.

Your ability to qualify for lending opportunities with reasonable repayment terms depends on a variety of factors which will be reviewed by the lending institutions and will affect the amount and terms of your loan.

Recognizing the differences between large corporate access to financing and small to mid-sized business access to financing is very important. Large companies and corporations have greater access to business credit and funding options with lower interest rates and more favorable loan terms.