Monday, January 24, 2011

Financing Your Business Part 2: Debt


Perhaps the most important reason why you, as a business owner, would want to (partly) finance a venture with debt is that you want to maintain majority or sole ownership and control of the business, which may be significantly diluted if you instead use additional equity financing, as was discussed in Part 1. Also, as I already mentioned in that post, while the business entity would have to be formed first (and in many cases, be in operation for a number of years) before a business loan gets approved, the entrepreneur can always use personal debt to supplement the initial equity raised.

Having said that, here are the most common sources of debt financing for budding entrepreneurs.

1. Credit card debt. Yes, I'm not joking: you can use your credit card to finance some of your business's capital needs. Not only that, it can be your cheapest source of financing if you play your cards right. Remember, you only get charged if you don't pay the entire balance on or before the due date; so the key is to use your credit card to buy some of your business needs, like say, your monthly inventory if you're running a sari-sari store, and pay the entire balance on the due date. Doing this is like getting a one-month loan at zero interest rate every month; as a deal, nothing can be sweeter.

Of course, paying beyond the due date comes at a terribly high price: credit card financial charges in the Philippines run at around 3.5% per month, or 42% per year (annual percentage rate or APR). So don't even bother using your card if you know you won't be able to wipe out the balance every month.

2. Cooperative/payday loans. If you're currently working, ask your more seasoned officemates the going rate for payday loans or for loans offered by your office credit cooperative, and you'll hear that it's anywhere from 1 to 5% per month (by the way, this is add-on interest, which is applied differently than the monthly compounded interest rate of credit cards); while not as high as the infamous "five-six" rates offered by loan sharks, 5% per month is still quite expensive. Still, you might find these loans useful because they are readily available and the application is usually hassle-free.

3. Loans from government offices (SSS, GSIS, Pag-ibig). Not a lot of people know this, but you can actually use all of those deductions you see on your paychecks to your benefit as early as two years after the start of your employment. For example, you can get a two-year, 24,000 peso loan from SSS at only 10% per year. Also, apart from housing loans (best rates in town if you're going to borrow 1 million pesos or less, by the way), Pag-ibig also offers multi-purpose loans and calamity loans to its members. Far from being worthless, these government agencies can boost your debt capacity and strengthen the capital base of your business.

4. Bank loan (personal). Sometimes banks offer really low interest rates for personal loans, like less than 1% per month, add-on, with borrowed amounts that can range from 10,000 to 500,000 pesos. The problem is, the application period may take some time, and there's no certainty that your application will get approved (I know a couple of people who have already been turned down even if they're capable of paying back the loans).

5. Bank loan (business). If your business is already up and running, and you need additional financing for expansion purposes, for example, you can get either a line of credit or a business loan from a bank. With a line of credit, an amount you apply for will be made available to you for a specified period of time; when you need the money, you can borrow or draw funds from this line at a predetermined interest rate, and you don't have to submit an application every time you borrow. SME business loans, like the ones offered by BPI and DBP, generally requires collateral.

In getting a bank loan for your business, it would help immensely if you already have a long and meaningful relationship with the bank, even just by maintaining a considerable deposit balance. With this kind of relationship with your bank, there's a higher chance of getting your loans approved, getting lower interest rates, and even securing a business loan for your new business.

6. SME business loans from other financial institutions. Like the ones offered by Small Business Corporation (SBC) and SSS. SBC even offers debt financing for startups, so just make sure that you have a sound business model and a well-prepared business plan for your new business. You can probably even get lower rates from these institutions than what most banks provide.

To end, just remember two important things before you borrow money for your business. One, by borrowing, you will be committing your business to a fairly large business expense (interest plus principal repayments), so make sure that you can generate enough cash flow (not profits, mind you) to meet these future needs, or your business falls to ruin. Two, even if you organize your business as a corporation or a limited liability company (each of which provides owners with limited liability for business debt, meaning creditors can only run after the assets of the business), almost all commercial lenders will require you, as the owner of a new or small business, to personally guarantee the loan with your personal assets through what is called a surety, a guarantee which essentially wipes out your limited liability. In other words, before you borrow any amount for your business, be ready to lose your shirt (and maybe your underwear too) if you're unable to repay your debt.

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