Getting a loan

Debt can help or hinder your business success. To tell the difference between “good” debt and “bad” debt, you can assess the level of risk involved as well as the likelihood of success.  

Good debt is generally any sort of debt that has a high likelihood of leading to increased future revenue and/or profitability. Profitability is how much money you have left after paying all your expenses. This kind of debt is likely to offer a strong return on investment and help sustain your business resiliency into the future. As such, this makes the accumulation of debt for these purposes a lower risk than other types of debt.  

For example, pretend you are a family care provider and you have been in business for years. You have a great reputation and have a strong and loyal parent following. You have a long waitlist and a number of parents asking you to expand your services, but you have already reached your capacity. You know of a potential viable location for a small center right in your neighborhood into which you could expand. Expanding your in-demand service to families in your area will enable you to increase revenue and profit for your business. In this case, the debt to expand your business can help scale your business growth.  

Bad debt, in contrast, is generally debt that is pursued that is unlikely to lead to increased revenue or profitability because you are uncertain of the outcome of the investment. As such, this type of debt is considered a higher risk since you might or might not see a return on this investment.  

For example, some child care centers under great economic stress take out loans just to survive a few more weeks. The investment was taken on simply to keep afloat. There was no plan to increase revenue or profit or to repay the loan. These providers did not have a sense of how they would recover or be profitable but took out the debt in hopes of buying time. In this instance, you might be able to extend the life of your business in the short term by taking out a loan; but, without a clear plan to increase needed profit and repay your debt, the loan will leave your business in a weaker financial position than when you started.  

Unethical debt is when a business borrows money for the wrong reasons. For example, a business owner might borrow money thinking they can get a lower interest rate than with a personal loan. However, they do not plan to use the money for the business. This is not a good use of a business loan. Besides creating a confusing financial situation, the business now has the added stress of paying back a loan that does not help the business make more money. This extra financial stress can cause problems for the business, even leading it to close. This decision could also cause legal problems or bankruptcy.

Regardless of the type of debt that you take on, it is important to thoroughly consider the pros and cons before jumping in. Taking on business debt is a big decision, so it is critical to think everything through beforehand, including your plan for repayment. To help you with this process, take a moment to answer the following questions. Such major decisions warrant taking time to consider your situation to ensure that you have clarity before you move forward. Take some time to put your thoughts on paper and review your answers before you act.   

• What am I going to do with the money? 

  First, decide if you need the money for a short time or a long time. This will help you decide if you need to pay it back quickly or over a longer period. For example, you might use a short-term loan to remodel your center and add a classroom. You need all the money at once but plan to pay it back within a year. A long-term loan might be for a bigger project, such as moving from a home-based child care program to a center in your community. In this case, it would take longer to pay back the loan. You would need a plan to increase your income and profits to pay it off, which will take time. As you can see, deciding to borrow money and planning how to pay it back depends on your vision for your business. It is important to clearly explain what you plan to do and why. This will help you create a good plan for paying back the money.

• Are families willing to pay for it? 

  When you think about this business growth, it's not enough to just think about what you want. You must also consider what you believe the market wants, or in other words, what the families in your community want and need. Consider our previous example in which a home-based child care provider is interested in transitioning to a center within the community. In this instance, it would not be as simple as saying, "I have a lot of families who are already using my services and others on a wait list" and then moving forward with the loan. You want to ensure that those families would be on board with your decision, or else the investment would not be as profitable as you expected. Do these families wish to move to a center with you, or do they prefer the home-based care that you already provide? Is the location desirable for them? Do the families on the waitlist feel the same as those already utilizing your services? It is important to write down whether or not you think families are willing to pay for your proposed change as well as the evidence that you have to support that.  

• How much money do I need? 

  Now that you have your vision written down, you can start to get an idea of how much money you need. This is not always as simple an answer as it seems on the surface. We recommend breaking out your costs into two general categories: 1) How much startup money do you need? 2) What's the long-term funding you will need?  

  Let's take an example of the home-based provider who's moving into a center. In terms of startup funding, the provider may need to pay the first and last month's rent on their new facility. They might need some money set aside to help renovate it before the center can open. Further, during the first few months that the center is planning on opening, the owner may need to invest in additional resources like an accounting system or child care management system. It is wise to budget for those resources and to write them down individually.  

  In terms of longer-term costs, the reality is that no business expansion is realized overnight, and long-term costs should be expected. As such, our example provider might wish to estimate the first six months of operation costs and factor those costs and anticipated revenue into the funding request. The provider should ask themselves, “If I had to be ready to open my new center tomorrow, what would I need?” They should also be certain that there will be adequate funds to keep the business running smoothly long enough to see the anticipated increase in generated profits. 

  Combined, you will want a safety net of funds that will ensure that you are successful in your endeavor and will not have to stop scaling before your growth is fully realized.  

• How is my credit?

   When you consider applying for a loan, you will need to think about your business credit and your personal credit. It is good to know your credit scores before you talk about getting a loan. Even if your business has been around for many years, you might not have good business credit if you have not used a business credit card or other loans. Like with personal credit, banks might be worried about giving you a loan if you do not have a good credit history. They need to be sure that you can handle the loan.

  Also, many business loans will require you to use your personal belongings and money as security for the loan. This means that your personal credit score may also be important. If you are concerned that your credit history and score are not as good as they should be, do not give up. As you try to get a loan, tell the people you are working with, such as a Small Business Development Center professional, a bank, or a financial technology company, about your credit and why you think it is the way it is. This will help them decide which loans might be best for you.

• Will I be able to repay the loan? 

  There are some types of debt that are less risky and more likely to help your business make money. However, any debt can become bad debt if you do not have a strong plan to pay it back. You will need to think about what the monthly payments will be and be sure that you can handle the cost until you pay off the loan completely. In most cases, you will want to figure out how much extra money you will need each month to pay back the loan (plus interest) over a certain period, while still paying your usual business expenses. Decide where the money will come from and what you will need to pay each month or year to pay off your debt by the end of the loan term (or the time you want to pay it off). An online loan payoff calculator can help you make sure that you have a good plan to pay back your debt on time. This will help you avoid any expensive problems for your business.

Once you know if you want a loan, how much money you need, and how much debt you already have, you will want to think about the types of funding available. There are many kinds of loans, but this section covers the ones that are most often used to help family care and center-based child care businesses.

Friends and family  

One common misunderstanding about business debt is that it always works like you see on TV. Someone has a great idea, goes to the bank, gets a big loan, grows their business, and everything is perfect. However, when you look at how businesses actually get money to grow, most often it comes from friends and family.

Friends and family already know you and may be more likely to believe in your vision for your business. Asking family for help could be as simple as asking your parents for a loan or a contribution to get you started. Another option is to ask friends and family who support your business vision to help through crowdsourcing. On sites like Kickstarter or GoFundMe, you can share your plan and funding goal and ask for help. Often, friends, family, and even strangers will come together to support your cause. Your friends and family might not be able to fund your business dreams, but it is always worth considering them as possible sources of support.

For example, a child care center that needed new playground equipment could have applied for a business loan or used a business credit card. Instead, they started a GoFundMe campaign. With support from friends, family, and the community, they raised the money they needed. This center, located in a low-income neighborhood, was able to reach people they knew and people they did not know. Their large social network came together to help them provide high-quality equipment for the children.

If you get funding from friends and family, it is important to treat the agreement like any other loan. This means putting the agreement in writing and not just relying on a handshake.

The agreement does not have to be a long, complicated contract, but it should include key details of the loan. These details should include how much money you owe and whether you also owe them a percentage of the business profits forever. The written agreement should also include the amount of each payment, the interest rate, and how much of each payment goes toward the original loan amount (principal) and how much goes toward the interest (the extra cost of borrowing the money). Make sure the amount due each month is clear, along with the total number of payments, the interest rate, and whether the interest is a set percentage of the original loan amount or a percentage of the remaining balance calculated each month. Finally, it is a good idea to have the agreement signed in front of a notary or witness to avoid problems later, even if it is a close family member. Remember to keep a copy of your agreement and follow the payment schedule just as you would with a bank or other lender.

Business credit cards  

Business credit cards are an easy way to get money for smaller, short-term needs. For example, you might not have enough cash to pay for a repair right now, but you know you will by the end of the month. You could use your business credit card in this case. A business credit card helps you build your credit history as soon as you open the account. This will be helpful if you need to borrow larger amounts of money in the future. The downside of business credit cards is that they usually have higher interest rates and may not give you access to enough money for a larger project.

Business line of credit  

A business line of credit is from banks or other lenders and is another great short-term loan vehicle. It acts similarly to a credit card but works for slightly longer-term purposes. For example, pretend you are expanding your business and you need to cover two weeks of payroll while new families are brought into your care. In that case, you may want to use a business line of credit. The advantage of business lines of credit is that they are flexible. At any time after you are approved, you can withdraw funds from the line of credit up to the full amount for which you were approved. You do not need to use the funds immediately, nor do you need to use all of it at once. The other advantage is that you may only take out the amount you need. For example, if you have a business line of credit for $10,000 and you only need $4000 temporarily, you can take out the $4000 and only pay interest on that withdrawal until you pay it back. You would still have the remaining $6,000 available to draw upon in times of need. The downside is that you typically have a much higher interest rate on the amount borrowed because it is short-term debt. As such, business lines of credit are best for short-term or temporary costs to cover immediate needs that can be paid back in a relatively short period of time.  

Term loans  

Term loans are a very common loan structure. Many mortgage loans are set up in this way. There is a set amount that you are borrowing that must be repaid by the end of the loan term, which means that there is a time when the loan starts and when it has to be completely paid off. There is typically an associated interest rate that may be fixed or may be variable, that is, it may change over time. These types of loans are usually best for a very specific project or activity in which you know how much it is going to cost overall and you have a sense of how it will fit into your day-to-day business. Most importantly, you know exactly how long you have to repay the debt.   

Your loan term could be 5 years, 10 years, 15 years, or 30 years depending on its size and type. The interest rate varies based on your circumstances and the current economy. Term loans might be a good option for expanding your playground if you know that you can pay it off within five years or even for purchasing a commercial property and paying it off over 20 years.  

Term loans are longer-term debt, which, of course, could put some strain on your business. The advantage is you typically know what the recurring payments are going to be and can figure them into your long-term budget.  

US Small Business Administration Loans  

One of the most common ways for small businesses in America to get the money they need to grow is through US Small Business Administration (SBA) Loans. These loans usually have lower costs and interest rates than loans you might get directly from a bank. This is because the government supports the loan. The EIDL loan, which was mentioned earlier, is only offered through the SBA. However, the small business loans discussed here are supported by the SBA but are given out by regular banks that have been approved to do this type of lending.

• SBA 7(a) Loan  

The most common and popular SBA program is the 7(a) loan, which provides loans of up to $5 million. The 7(a) loan can be used for working capital to keep your business going as well as expenses like real estate, equipment, and other purchases that you make to expand your business. Usually, the interest rates are somewhat low, and the repayment periods are longer term (10 to15 years). One challenge to getting a 7(a) loan is that they typically go to businesses that have some established business credit history. If you need a loan, the SBA 7(a) loan is still worth talking about with your lender even if you have concerns about your credit history; but, it is worth being aware that this could impact your ability to qualify.   

• SBA 504 Loans  

504 loans are typically used to acquire or expand real estate. If you are looking to go out and purchase a new facility, including the center and the land, or you need to renovate a large playground, this might be a good loan option for you. The 504 loan usually requires you to show that at least 10% of the down payment is going to come from your own business funds. The rest of the money can come from community-based lenders and other traditional banks supporting it.   

• Microloans  

Finally, microloans are small loans from the SBA for up to $50,000. Usually, these will come from community development institutions, not from commercial banks. The average amount of a microloan is $14,000.  

Microloans are useful for shorter-term projects which don’t require a whole lot of money, but the cost is larger than the limit on your business credit card. Microloans are often a good option for businesses that don't have much of a credit history because they are less difficult to get than other loans, such as the 7(a) loan.  

Often when a child care business owner goes to get a loan, the meeting can very much feel like an interview focused entirely on the owner. You will likely be asked questions about your credit history, business, and vision. This can create the illusion that everything is up to the lender to decide. However, remember that you also have the right to make sure that the lender is a good fit for your business. It is imperative to ask your lender questions to ensure that your specific needs are met. The right loan can tremendously help your business whereas the wrong loan can damage or even end it.  

• Does this lender understand child care? Does this bank truly understand your business, both where it is right now and the directions it can take in the future? Is this lender only used to working with other types of businesses in dissimilar industries? Maybe they typically lend to factories in the area and therefore they might not be able to understand your specific needs. 
• Is the debt too short or too long? If a loan needs to be paid off too quickly, it could lead to bigger payments that can swamp your business. If the loan needs to be repaid over a long period of time, you could face higher amounts paid in interest on the loan. If the loan is for a long duration, you will want to ask if you can pay the loan off early without penalty since paying off debt early can save you thousands of dollars in interest. 
• What is the total cost of the loan, principal, and interest? Interest rates add up. Sometimes we look at the amount borrowed and at first glance and assume the monthly payment seems quite manageable. For example, pretend you have a minimum monthly payment of $300 and you feel confident that you can make that payment each month. However, that payment will include the interest due. You could end up with only a small portion of your payment going toward your principal balance and reducing the total amount that you owe. This can result in very large amounts of interest paid over time and in cases where the loan term is not fixed, can leave you making payments for longer than you had originally intended. For this reason, it is critical to be aware of your interest rate and the total cost over time as you weigh the pros and cons of your loan options. 
• When is the first payment due? In some cases, your first loan payment could be due right away. In other cases, only interest may be due for a portion of your loan term and the principal balance may be added to the monthly amount at a later date. Be sure that you are clear on when your first loan payment is due and what it will include so that you can plan accordingly with your business. 
• How long will the application process take? You should also find out what the loan application process is like and how long it will take. Ask your lender what forms you need to fill out, what documents you need to provide, and what your chances are of getting the loan. Make plans while you wait for the loan decision. You should also decide if the time you spend on the application will be worth it, based on how likely you are to get approved.

After you have answered all these questions, talk to current and past customers if you can. Ask the bank to give you the names of people and businesses they have worked with in your area. It is best if these are child care businesses so you can learn about experiences that are similar to yours. Another way to learn more about lenders is to ask your friends and family if anyone has gotten a loan from that bank or institution before and what their experience was like. This information is very important for making a good decision. In the end, it is not just the bank's decision; it is your decision as well.

Disclaimer 

The information contained here is for educational purposes only and is not intended to constitute legal, tax, or financial advice.