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What Every Entrepreneur Should Know About Taking on Debt

If you have a short-term financing problem, it’s best to think beyond your nose.

Too often, struggling entrepreneurs get so wrapped up in their current state of affairs that they don’t make the moves they need to reach the proverbial light at the end of the tunnel.

I just heard from a client whose situation is a perfect illustration. The client has a large order he’s trying to fill with Walmart. Orders with Walmart are a good thing. The problem is, he needs about $300,000 to be able to fulfill the order. He has three options:

  1. He could not fill the order.
  2. He could take out a short-term loan for $300,000 with an online lender that would cost about $75,000 in fees and interest.
  3. He could replace his regular line of credit with an asset-based line of credit secured by accounts receivable and inventory. The cost again would be about $75,000, but he would have a longer time to repay the loan. 

With an asset-based line of credit, a lender is generally willing to advance you 85 percent of accounts receivable and 50 percent of inventory. This option offers more flexibility than a standard line of credit which as a general rule, a lender will only extend about 10 percent of a company’s top-line sales.

Taking on Debt Isn’t a Non-starter

The third option is my choice — and it’s not even particularly close.

Not filling the order is akin to business suicide. Snubbing Walmart is going to hurt your reputation throughout the business world. Nobody will trust you. This idea is a nonstarter.

The short-term loan feels more like a last resort if, for some reason, you can’t execute the asset-based line of credit strategy.

Assuming the client has a good product and can deliver that product as described, on time and in the proper quantity, Walmart will likely place future orders.

Also, using the asset based line of credit will spread out your payments throughout the year; with the short-term loan, you’ll have to pay the whole thing back in a couple of months, which will place your financials under significant pressure. The entrepreneur might also have to repeat the short-term loan depending upon issues such as order timing. 

I realize the mindset of taking on debt is a scary proposition, but if an entrepreneur has confidence in himself/herself, a worthy product or service and a sound business plan, it’s worth taking the risk. People seem to forget the whole point of longer-term loans is to make more significant debts more manageable; they seem to understand this when it comes to car and home loans, so what’s the difference with a business loan?

Be Bold

I enjoy working with entrepreneurs because they’re interesting people. They often see the world differently than others and understand the need for new (or better) products and services.

Like in Star Trek, entrepreneurs often “boldly go where no one has gone before” — to an extent. When it comes to financing, many entrepreneurs turn into wallflowers. And that’s what often sinks their business.

Ultimately, success in business mostly comes down to believing in yourself- and sometimes taking on more debt. The old saying that you have to spend money to make money is never more true when it comes to entrepreneurship.

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