Getting a loan

Debt can help or hurt 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. This makes the accumulation of debt for these purposes a lower risk than other types of debt.  

For example, pretend you're a family care provider, and you've been in business for years. You have a great reputation and a long waitlist of waiting for you to expand your services, but you're at full capacity. You know of a location for a small center in your neighborhood into which you could expand. Expanding your in-demand service to families in your area enables you to increase revenue and profit for your business. In this case, the debt to expand your business can help grow your business.  

Bad debt is debt that's unlikely to lead to increased revenue or profitability because you're uncertain of the outcome of the investment. This is considered high risk since you're unsure if you'll 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. These providers didn't have a sense of how they'd recover or be profitable but took out the debt in hopes of buying time. In this instance, they may be able to extend the life of their business in the short term but, without a clear plan to increase profit and repay the debt, the loan will leave the business in a weaker financial position.  

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 don't plan to use the money for the business. Besides creating a confusing financial situation, the business now has the added stress of paying back a loan that doesn't help the business make more money. 

Taking on business debt is a big decision, so it's important to think everything through, including your plan for repayment. Take a moment to answer the following questions: 

• What am I going to do with the money? 

  Do you need the money for a short time or a long time? This helps you decide if you need to pay it back quickly or over a longer period of time. 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 this case, it would take longer to pay back the loan. You'd need a plan to increase your income and profits to pay it off, which takes time. 

• Are families willing to pay for it? 

  When you think about business growth, consider what the families in your community want and need. Ensure families are 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? 

• How much money do I 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 or money to help renovate before the center opens. The owner may need to invest in an accounting system or child care management system. 

  Our example provider might 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 opened my new center tomorrow, what would I need?” They should be certain that there'll be enough funds to keep the business running smoothly long enough to see the anticipated increase in generated profits. 

• How is my credit?

  It's good to know your credit scores before moving forward with getting a loan. Banks might be worried about giving you a loan if you do not have a good credit history. Many business loans require you to use your personal belongings and money as security for the loan (collateral). 

• Can I repay the loan? 

  There are some types of debt that are less risky and more likely to help your business make money. Think about what the monthly payments will be and make sure you can handle the cost until you pay off the loan completely. Figure out how much extra money you'll need each month to pay back the loan (plus interest) over a certain period, while still paying your usual business expenses. An online loan payoff calculator can help you make sure that you have a good plan to pay back your debt on time. 

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  

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. If you get funding from friends and family, it's 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 should include key details of the loan, including how much money you owe, whether you owe a percentage of the business profits, payment amounts, interest rate, and how much of each payment goes toward the original loan amount (principal) and how much goes toward 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. Sign the agreement in front of a notary or witness to avoid problems later, even if it's a family member. 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 is helpful if you need to borrow larger amounts of money in the future. The downside of business credit cards is 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 option. It acts similarly to a credit card but works for 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. The advantage of business lines of credit is they're flexible. You can withdraw funds from the line of credit up to the full amount for which you were approved. You don't need to use the funds immediately, nor do you need to use it all 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 $4,000 temporarily, you can take out the $4,000 and only pay interest on that withdrawal until you pay it back. You'd still have $6,000 available to draw upon in times of need. The downside is these usually have a much higher interest rate on the amount borrowed because it's short-term debt. These are best for short-term or temporary costs to cover immediate needs that can be paid back in a short period of time.  

Term loans  

There is a set amount that you are borrowing that must be repaid by the end of the loan term, which means there's a time when the loan starts and when it has to be completely paid off. There's an interest rate that's fixed or variable (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'll fit into your day-to-day business. Your loan term could be 5, 10, 15, 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 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. These small business loans 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 lower, and the repayment periods are longer term (10 to15 years). One challenge to getting a 7(a) loan is that they're usually approved for businesses that have 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.

• SBA 504 loan  

504 loans are usually used to acquire or expand real estate. If you're 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 option. 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  

These 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.  

Ask your lender questions to ensure your financial needs are met.  

• Does the lender understand child care? Does this bank understand your business?  
• Is the debt too short or too long? If a loan needs to be paid off too quickly, it could lead to bigger monthly payments. If the loan needs to be repaid over a long period of time, you could face interest on the loan. If the loan is for a long time, 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. 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? Your first loan payment may be due immediately or a later date. Make sure you're clear on when your first payment is due. 
• How long will the application process take? 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. 

Disclaimer 

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