Can a business borrow some money for the short-term to help
cover expenses while building revenues? Yes, and the way to do this
type of deal is to secure three or four investors to lend your
business funds as part of an overall one-year to 18-month plan. The
big picture is that this format is really a series of short-term
loans perfectly sequenced to fit end to end. There are many
companies who have used this successfully to keep cash flow flowing
while they build and implement the firm's sales and marketing
plan. The first four or five monthly payments can actually be made
from the proceeds of the loan, provided there is a successor loan
set to kick in on the back-end of each credit extension. And owners
should understand that each successive round of funding should be
an increased level compared to the prior level. There are
significant risks involved in pursuing this kind of a deal, but
there are also some very attractive potential benefits that buy
your company some time to get established in the market.
Here's how it can work. A company sets up a three-month line
of credit for, say, $35,000 (must be repaid in full in 90 days).
The annual equivalent interest at 7 percent is around $2,400, so it
costs about $200 per month "interest-only" for the first
three months the $35,000 is accessed. The company sets aside $5,000
to make a 90-day principal payment that could trigger a 30- or
60-day extension of the original terms. This serves as a fallback
position in case the subsequent second loan is not ready for some
reason on the 91st day. The company can now use more than $29,000
for operations over the next 90 days, and even without revenue, it
can make the $200 interest-only payments each month and have $5,000
set aside to make a principal reduction payment in case they need
to keep this line open for another one to two months.
At the 91st day, a second lender steps in with perhaps a $50,000
working capital credit line for another 120 days. This loan is
fully amortized over the four months and requires monthly payments
of $12,682 (principal and interest) to stay in good standing. The
first month's payment is held in a money market account for
that initial payment due in 30 days. Now the company has use of
around $25,000 (half the loan) for 60 days until payment number two
is due, and another $12,000 for the following 30 days out to the
end of the third month. By then, the firm will have secured a few
early sales on its marketing plan, and a few of these will have
already been collected and can be used to pay for some operations
items.
Content Continues Below
New sales are then stockpiled toward the final $12,682 payment
that fully retires the loan, and the third short-term loan is then
set to begin. This time, the company now has two positive credit
ratings on its record and qualifies with another line for $100,000
and a one-year term, and perhaps the loan is now structured as
interest-only on a quarterly basis. That requires payments of only
around $600 per month, and the firm could hold back one-third
($33,000) of these funds to make a "good faith" principal
payment in the fifth or sixth month. This demonstrates to the
lender that the company can handle its debt service and principal,
and it helps build a very favorable credit rating for the firm.
There are risks, of course. If the firm does not generate sales
and any loan cannot be extended, and all the loan proceeds have
already been spent, then the lender will foreclose on the principal
and the owner(s) could be personally liable for repayment, or
assets pledged as collateral could be seized to repay the
principal. But these risks are manageable if the owners don't
use all the funds at each access point and reserve a portion of the
principal for monthly debt service and/or a "good faith"
early principal portion repayment.
David Newton is a professor of entrepreneurial finance and
head of the entrepreneurship program, which he founded in 1990, at
Westmont College in Santa Barbara, California. The author of four
books on both entrepreneurship and finance investments, David was
formerly a contributing editor on growth capital for Industry
Week Growing Companies magazine and has contributed to such
publications as Entrepreneur, Your Money,
Success, Red Herring, Business Week, Inc.
and Solutions. He's also consulted to nearly 100
emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those
of the author, not of Entrepreneur.com. All answers are intended to
be general in nature, without regard to specific geographical areas
or circumstances, and should only be relied upon after consulting
an appropriate expert, such as an attorney or
accountant.