Most people believe that one should never accept high interest rates on money borrowed. If you think this is always the answer, then you might want to read on and think again.
Yes, it is prudent to get the lowest rate possible when you can get the funds that you need to fulfill your plan. BUT, and that is a very big BUT! Consider the case where one can grow beyond self imposed growth limitations.
I’ll start my case discussion with a couple of concepts: controllable growth, lending constraints, value received and contribution margin.
Controllable growth will be different for every company, largely because of differing strength of management, resources, and processes. Nothing in this blog means to suggest that any company should grow faster than the rate that they can control. Nevertheless, I have found that many companies do have the ability to grow but are constrained by a lack vision and of capital. Typically, their management is focused on “not paying taxes”, or avoiding interest expense at all costs. Their shortsightedness is their true constraint.
As we look at lending constraints, let’s look at standard bank financing first. Banks are valuable lending entities that tend to have comparably low rates. Their acceptable risk profile is usually limited by five components, the company’s leverage and their historical ability to service term debt. Primary source of repayment must be also supported by a good back-up plan, or secondary source of repayment, followed by the payment history of those involved. The bottom line is that many businesses can only obtain enough bank credit to traverse a slow growth curve. In many cases this is the wise path. Though, there are many cases where a given company’s management wants to grow faster than they can with limited availability of credit. It is those instances that I’m focusing on here.
It is easy for a business owner to think of financers as just a conduit for money. Many also believe that loans are a commodity. My meaning here is that they think all loans with the same interest rate are the same. Conversely, I have found that initial loan conditions plus banker’s flexibility and patience toward variations in business plan implementation are differentiators. Also financers can add value through their connections, knowledge & experience, and direction. It is important to understand all of the benefits you receive when dealing with a particular financer.
Contribution margin is a concept that deserves its own blog. One can Google the subject and be blasted by charts and graphs and heavy “accounting speak”. It is truly appropriate for all business owners to fully understand contribution margin, so read as much as you can. The quick explanation is that contribution margin is the profit value of an incremental dollar’s increase in sales. This is important because it enables management to make valuable decisions about when to continue to grow and when enough is enough. One more thing about contribution margin is that you do not calculate it by looking at your net profit percentage. You just look at costs that vary with sales. Fixed costs or overhead remains constant, therefore additional sales yield more profit than just the historical net profit percentage.
Let’s say you have outstretched your growth based on borrowing availability at cheap lending rates, yet more money is available at higher rates. Let’s also say that the higher rates still allow for growth and increased profits. Then why would you choose to miss the opportunity just because you are overly focused on the wrong thing?
Indeed, many businesses make the shortsighted mistake of bridling their growth just to avoid taxes or get the lowest interest rate. Cheaper isn’t always better. Conditions, flexibility, customer service, and the ability to achieve your goals are all worthy of consideration.
Feel free to give me a call and I’d be happy to talk with you about what is constraining your growth and ways to overcome roadblocks to success.
Bob Stackhouse, President, Asset Commercial Credit © Bob Stackhouse
