The Real Cost of Financing

When evaluating financing, consider more than rates, fees, and monthly payments.

Last week, I had two conversations with business owners that got me thinking about how we make financing decisions. The situations were very different, but they both raised the same question: When we consider borrowing money, how much should the cost of that money influence our decision?

The first conversation was with a contractor who’s been in business a long time and does public works projects. He’s facing a cash crunch for about 30 days until his next contract kicks in. He needs money quickly to bridge the gap.

There aren’t many good options when you need money that fast. Banks generally can’t move fast enough, and an SBA loan won’t happen in 30 days. One possibility is a short-term online business loan. These loans are often incredibly expensive, and I’ve spent much of my career warning business owners to be careful with them.

But every situation is different. If this contractor has money coming in that he can reasonably count on, and the problem is really a short-term timing issue, one of these loans might make sense. But he’s drawn a hard line against online loans. He can’t get past how expensive they are. He told me he’d rather shut down his business than take one.

That really struck me. I understand why he feels that way. I don’t like these loans either, and in many cases, they can make a bad situation much worse. But I also wonder whether he’s so focused on the cost of the loan that he’s not thinking enough about the cost of shutting down a business he’s spent years building.

I don’t know his entire story. You can’t understand everything that’s going on inside a business from one conversation. Maybe there are other problems, and maybe shutting down is the right decision. I certainly wouldn’t encourage him to take an expensive loan without understanding how he plans to pay it back.

But I think caring for businesses can be a little like caring for people. Sometimes they get sick. Sometimes they need medicine that isn’t particularly pleasant, and sometimes that medicine is expensive. You don’t want to take it unless you have to, but sometimes the alternative is worse. If a very expensive loan gets this contractor through a temporary cash crunch and allows him to keep operating a viable business, is it really such a terrible decision?

This was a very successful company that had been around for many years. Last year, the owners decided to diversify into an entirely new product line. They were essentially starting a new business inside their existing business, and they had choices about how to finance it.

One option was to finance the new venture separately, potentially through an SBA loan. But they already had an established banking relationship and existing credit lines, and their bank was willing to let them use those facilities to fund the expansion. The money was cheaper, so they went that direction.

I can understand the thinking. If a bank will lend you money at a relatively low interest rate, why go through the time and expense of arranging another loan? Unfortunately, the new venture hasn’t gone as planned. It’s taking longer to get off the ground and become profitable, and it’s required considerably more money than the owners originally anticipated. None of this is particularly unusual for a startup. Even with experienced owners and an established company behind it, starting something new is hard. Things often take longer and cost more than expected.

But here’s where the financing decision has come back to haunt them. Because they funded the new venture through their existing credit facilities, the startup's financial struggles are now affecting the entire company. They’ve violated covenants with their bank, strained their liquidity, and face restrictions that affect how they run the business they’ve spent years building. What started as an investment in a new opportunity has created problems for an otherwise successful company.

Would things have been different if they had financed the startup separately? Possibly. It would have depended on how they structured the financing, what guarantees were required, and whether their existing bank would have allowed it. But at least they would have had the opportunity to think through how to contain some of the risk. Instead, they chose the cheaper money, and now they’re paying a price that goes well beyond the interest rate.

I've been thinking about these two conversations together.

In the first, a business owner is so opposed to expensive financing that he's willing to consider shutting down a business he's spent years building. In the second, the owners were attracted to cheaper financing, and that decision has created problems they never anticipated.

The situations are very different, but I think the underlying issue is the same. In both cases, the cost of money is driving the decision, perhaps at the expense of considering the bigger picture.

I'm not suggesting the contractor should automatically take an expensive online loan, or that the second company necessarily should have taken an SBA loan. I don't know enough about either situation to say definitively what they should have done.

But both stories illustrate something important. When business owners evaluate financing, what seems like the obvious or most economical choice at the time can come back to haunt them later.

One of the most important goals of a financing strategy is to preserve as much flexibility as possible, recognizing that things rarely go exactly as planned. Interest rates, fees, and monthly payments matter. A lot. But so do the risks you're taking, the options you're giving up, and what happens if things don't work out the way you expect.

Sometimes the most expensive money is the right choice. And sometimes the cheapest money turns out to be the most expensive decision.