Time after time, I've run across companies that make a rough financial patch much worse by "solving" their problems with short-term loans. Here, I'd like to modify Nike's famous slogan and tell business owners considering taking a short-term loan to "Just Don't Do It."
Case in point: I recently received a call from a retail business I consulted with about a year earlier. The company had recently taken a four-month loan with an annualized interest rate of 200 percent. They never realized the rate was that high.
The owner wanted to get an SBA loan now to consolidate his debt, but he's not making a profit so he couldn't get a loan. Also, he's making a daily repayment of several hundred dollars, which puts pressure on his entire operation.
Tempting but evil.
What exactly are short-term loans?
Short-term loans generally are easy to obtain. The loan process takes only a couple of days, and you can apply online. Borrowers don't need extensive credit histories or even good credit scores to be approved.
The ease of securing a loan is helpful to struggling businesses because it offers increased cash flow. That might mean making payroll or paying rent if you're otherwise stuck waiting for accounts receivable
It also might allow a business to take advantage of a short-term opportunity. Say, for example, that you'd be able to buy critical raw material for half price for a limited time. Those savings might enable you to increase your profit margins or expand your production.
But the price you're going to pay is a high one, in more ways than one.
The interest rate surely will be outrageous--triple figures aren't out of the question--and the repayment terms will be onerous and frequent. If your business doesn't have a regular cash flow, this can be especially problematic.
The other main problem with a short-term loan is that it can lead you into a debt cycle that you're unable to break. It's not uncommon for companies that take out a short-term loan to take out another one before the first one is paid off. That debt cycle can then become a death spiral.
I counsel clients not to fear debt--but it has to be the right kind of debt. That's not a short-term loan.
A different path.
So, what should my former client have done instead of taking a short-term loan? I would have told him to forgo the loan and cut expenses.
Entrepreneurs are conditioned to be in growth mode perpetually, but no business grows in a straight line, and downturns are a part of the process. Hunkering down and even shrinking your company during stress points is a viable option, and it's certainly better than getting stuck in a debt cycle.
Now, my client's only slim hope is to avoid further debt and cut expenses to the bone, but it may be too late. Don't make this same mistake yourself.