Loan to start a business. Should he be afraid? Why small businesses should not be afraid to take out loans: how to use them wisely
It is very dangerous, but not for you, but for the bank, which is why banks do not issue loans to startups. But all companies and businesses that exist in the world are built on borrowed funds. And your business will also be built on borrowed funds. But at different stages of life, the company uses different sources of money.
Companies take loans from banks at a time when the business is already built, and the entrepreneur needs more money in order to expand, or just needs to close. The entrepreneur understands, for example, that there was money, there will be money, but now there is no money, and he asks the bank for it. Even for well-performing and stable companies that do not create a working capital reserve, situations can regularly arise when payments to counterparties need to be made today, and payments from clients for completed contracts will arrive only a month later.
The company goes to the bank and usually gets a loan at a low rate if it can prove that it runs a stable business and receives constant payments from customers for its services. This is similar to the situation with your credit card, which has an overdraft. You ran out of money two days before your salary, the bank sees that you generally have regular cash receipts, and lets you go negative for free, return it in two days. So it is with companies: if , the bank will most likely give the company a very cheap loan, because it knows that it will receive payment from customers and return it. You will need to be able to repay the borrowed funds, and then your company will receive a loan.
When we talk about risks in economic decision making, we relate the risks to the potential reward that can be obtained if this risk is taken on. This is how entrepreneurs assess the situation when they decide to replenish the working capital of the company and invest in a new division of their business, for example, open a new cafe. They compare how much money they need to spend now and how much potential profit growth they will receive after a certain period. And in the same way, investors assess the situation, who think whether it is worth giving you money, and how much they can earn in the future.
The bank operates in the same logic. When giving you a loan, he thinks about what percentage he will earn and what is the risk that you will not return the borrowed money. In a simple model, the higher the risk, the greater the potential payoff.
The bank issues a loan to the company to earn on the interest that the company pays on the loan, and on additional services and commissions that the company will pay to the bank if it does not return the borrowed funds on time. This means that the bank will earn not a very large percentage on such a loan. If the earnings are not very high, then the risk should not be very large.
The higher the risk, the higher the potential reward should be. Banks operate in situations of lower risk than investment funds and others. If you are just starting a company and you really believe that you will succeed, you can try to convince those who regularly invest in new businesses that your idea is attractive.
Since a startup cannot predict expected cash flows with sufficient accuracy, it borrows money not for return - in the form of a loan, but immediately shares equity capital with those who are ready to invest in its initiative. That is, you are going to build a restaurant while you have only expenses, and you promise someone who is ready to give you money not that you will return it within a certain period (you cannot make such a commitment, because there is no certainty), you immediately give the investor a share in the ownership of this business.
Often investors who are ready to give money to a business that has not yet been built try to reduce their risks and organize mentoring programs and incubators so that early-stage companies that have passed the competitive selection can learn how to do business from the mentors that the fund has collected for them. lending funds. So, an investor shares not only money, but also expertise in the industry, he increases the chances that your company will grow, and he will become a co-owner of a large and successful business.
Returning to the question of the dangers of taking money to start your business - you can only answer this question for yourself. Absolutely every company that exists in the economy at some stage was built on borrowed funds, because their founder believed that he could build something more. This is how entrepreneurship works and this is how the economy works. The business is built on the founder's belief in his own strength, willingness to take risks and willingness to work hard and overcome difficulties. The bank cannot decide for you whether it is dangerous for you personally to engage in business. Only you can decide this for yourself.
Initially, few people like the idea of using a loan and becoming indebted to the bank. After all, it is very profitable not to depend on anyone and develop a business with your own money. This contributes to greater confidence in the future and more restful sleep. But this is just an illusion of stability.
If a business has growth potential that is not being realized, competitors will try to push you out of the market. Even if you personally are ready to be content with little, this is unlikely to make them show condescension towards you. As they say, we live in a society and cannot but depend on it. In business, this means the following: we cannot ignore the actions of competitors.
Most entrepreneurs have their own idea of how to make a business better and get more income. Someone more risk-averse will take out a loan and use it to grow a business, which could weaken the position of other market participants. After all, investments are both the modernization of equipment (and, as a result, the improvement of the quality of products or services), and the opportunity for expansion in the market (with a corresponding increase in market share).
However, the use of credit funds does not automatically guarantee benefits to anyone. On the contrary, misused credit can undermine the company's financial position. It is difficult to foresee such consequences in advance. Only after some time it becomes clear who exactly - you or your competitors - had a more correct business plan, more correct goals, who was consistent in achieving goals and invested money efficiently.
So should I borrow, and if so, how much? There can be no general recommendation here. Depending on the industry, the comfort level of debt can vary greatly. For grocery chains, the ratio of net debt (net debt is understood as the sum of a company's short-term and long-term debt on loans and borrowings minus free cash on accounts or on hand) and EBITDA as 4:1 is considered to be a favorable level, that is, net debt is more than annual profit in four times. For capital-intensive companies, a ratio of 3:1 - 2:1 is considered acceptable. The optimal indicator depends on the current situation of the company, the business qualities of its leaders, business strategy, and economic trends.
Immediately after the crisis, companies tried to optimize the structure of the loan portfolio by reducing rates, lengthening or refinancing debts. At favorable times, large organizations have the opportunity to sell their shares on the stock exchange and use the money received to pay off debts or further expand their business. Small and medium-sized companies do not have such opportunities, so they need to seriously and carefully consider every decision related to raising borrowed money. Leveraged funds can help your business generate more revenue and strengthen your market position, but there is always the risk of borrowing money to make your company worse off. What mistakes do entrepreneurs make most often when lending?
Unnecessary Acquisitions
"Other" money is psychologically easier to spend than money earned by one's own labor. Hence there is a risk of irrational use of borrowed funds. Often, things that seem necessary at first glance are acquired, but in fact they do not directly contribute to increasing profits, and even vice versa. Hiring secretaries and a large number of employees, buying overly expensive office furniture and equipment, and other non-essential expenses at first can seriously undermine the company's financial condition. It usually becomes apparent later that all this could have been easily dispensed with.
Marketing and sales are not in the first place
It is dangerous to invest in the development of a company's fixed assets, for example, buying equipment to increase production capacity, without having clear ideas about how to expand the customer base, or without prior agreements with them. Even Gazprom extracts gas and builds gas pipelines, in principle, only after signing contracts with buyers. You will always have time to buy equipment, but finding a sales market is much more difficult. If the investment does not attract additional buyers, then it is worth buying new equipment only if it leads to a decrease in your costs.
Loan for the duration of the production cycle
For long-term success, you need to correctly correlate the terms of the loan with the speed of turnover. For example, terms of lending for commodity transactions are 3-4 months, but by taking a loan for such a period to ensure the next production cycle, the borrower is approaching default. The matter is that the real period of crediting of the majority of trading operations significantly exceeds the duration of one turnover. In fact, repayment of the loan is possible only with the accumulation of net profit, which is equal to the amount of the principal debt. Therefore, the feasibility study for projects should have a much more distant horizon.
Overdraft loan
If you already have a debt load that is 2-4 times your annual income or exceeds your annual revenue, you should carefully consider all further steps in lending to a business and, possibly, look for another source of financing. It is often time to say “stop” to yourself, no matter how tempting development prospects new money opens up for you. It seems that the market is growing and everything should be fine. But it is better in such a situation to focus on reducing costs. It's amazing how many credits you can collect in a short period of time! Getting credits is not very difficult, it is even easier to spend them. The most difficult thing is to make a profit from them and pay off the bank.
Miser pays twice
Being stingy, like spending too much, is also bad for business. In this case, we are talking only about the most useful, the most necessary for the company. If some acquisition allows you to reduce your costs several times, then there is no need to be greedy. If you need valuable advice that will help you avoid a lot of mistakes and get you out of a dead end, feel free to pay qualified consultants for it.
Financing activities only through loans
Loans are nothing more than an auxiliary way of financing a business. Initially, the company must have a significant part of its own funds. And then the financing of the business should come mainly from profits. Naturally, what you earn should be enough "for life", but buying expensive cars and other "toys" from the profits can ultimately bring the business to naught. By the way, many large companies finance business mostly from profits, spending 10-20% of net profit on dividends or not paying them at all. The exception is companies operating on the international market, which pay large dividends, based on the practice of developed Western countries, at the level of 40-50% of net profit (MTS, Vimpelcom, TNK-BP, CTC Media, etc.).
Lack of free cash
Borrowing if you don't have any account balances, or going all-in and immediately spending all the money you borrowed, seems too risky. There is a saying: "The bank gives an umbrella when the sun is shining, and takes it away when it rains." This, of course, is an exaggeration, but partly true, because the lack of any liquidity indicates problems in the client's business itself, and not about the bank's excessive caution.
Fear of attracting an investor
You should not categorically reject the option of selling a company's share to an outside investor. Now there are many investment funds or wealthy people who are ready to invest in the development of your business, buying, for example, a quarter or a third of the company. It is possible that this will not be forever, but only for a certain period, for example, for three years, when the funds provided by the investor will work and seriously increase the value of the company. The search for an investor should be approached very carefully and work only with trusted people and funds, whose good business reputation has been confirmed more than once.
Wrong time-money ratio
Too hasty, early closing of the loan can cause a loss of profit. Conversely, often stretching the repayment over the entire predetermined period can also harm the business, diverting extra money to pay interest.
Case Studies
The position of Rusal, which was trying to develop rapidly in many directions at once, was greatly shaken during the crisis due to the fall in aluminum prices. The worst situation was at the end of 2009, when the debt was 22.9 times the profit. By the end of 2010, this figure was normalized to 4.4:1.
For several years, the debt load of the 36.6 pharmacy chain has been considered high, although the company does not allow delays in its obligations. She needs money for large-scale expansion. At the end of 2010, its ratio was 4.8:1, and EBITDA was only one and a half times the amount of interest payments. Bonds "36.6" in the stock market are considered a speculative high-risk instrument.
Investing heavily in development and teetering on the verge of profitability in terms of net income, the Rosinter restaurant chain successfully reduced its net debt/EBITDA ratio to 1.1:1 in 2010 compared to 2.97:1 in the previous period.
The discounter Magnit, which opened many stores in 2010, still has a low leverage of 1.39:1, since in 2009 it recorded a minimum value of 0.09:1. To strengthen its position in the market, it is necessary to occupy the main competitor of Magnit - X5 Retail Group (Perekrestok, Pyaterochka, Karusel stores). But the company has an even more aggressive debt policy, resulting in a 3.7:1 ratio at the end of 2010 compared to 2.08:1 at the end of 2009.
Sergey Ivchenkov, financial consultant at Boring Finance, explains why it will be difficult for small businesses to become medium or large without attracting loans and gives advice on how to use borrowed money correctly.
There are two kinds...
Often, entrepreneurs resort to loans only to get rid of financial problems in business. When they take it, they have a mental itch - how to return it as soon as possible and stop walking in debtors.
Others, on the contrary, take loans and do not think about the consequences. And after some time they are drowning in more and more new loans. Warren Buffett in 1991 said that Donald Trump fell into such a trap - he did not think about how his loans would pay off.
Borrowed money can be used for business development, but only under certain conditions. Let's consider in what cases borrowed money will help a business grow and how to translate the effect of them into understandable numbers.
You can grow with your own money. But long
“Banks are cashing in on us”, “You take someone else's - you pay your own”, “I develop purely with my own money” - with this way of thinking, small enterprises most likely will not evolve to medium-sized businesses, even if they are very profitable. And if they evolve, it will take many years.
Imagine that you opened a business by investing 2 million rubles in it in the first year. Everything is so cool with you that every year you earn 50% on top. Everything you earn, you send back to the business.
Let's calculate how much you earn in 10 years:
1 year. 2 million + 50% = 3 million
2 year. 3 million + 50% = 4.5 million
10 year - 115 million
10 years have passed. The amount of money you have in your business has gone from 2 million to 115 million. This is despite the fact that you did not pay yourself dividends and invested all the profits back. And 115 million capital is not even an average company. It turns out that you work hard for 10 years, all this time you eat buckwheat even without cutlets, and the business is still small.
Beeline and Magnit develop differently
Medium and large companies are not afraid to use loans to grow their business. Let's take as an example two medium-sized companies - Beeline and Magnit. In 2017, Beeline has twice as much foreign money in business as its own. Magnit has approximately the same amount of its own and borrowed money.
Credits, when done right, are like nitro boosts in cars. But just like in a car, you shouldn't turn it on just like that.
When can I get a business loan?
Before you take out a loan for development, check whether you meet two basic conditions.
1. Return on assets above a percentage
Assets are everything a company owns: money in accounts, machines, machines, receivables, inventory, real estate. Using them, the company earns profit. Return on assets (ROA) is used to understand how much profit a company is making from its assets.
Return on assets (ROA) = earnings before interest on loans and taxes / sum of all assets.
Imagine a custom furniture manufacturing company. Its owner went to the bank to take out a loan - he already wanted to sharply raise his business. Took money at 15% per annum. Put them in and got ready to take off. After a while, he realized - the profit does not increase.
It turned out that the profitability of the company's assets is below 15%. In other words, the company earned less from the borrowed money than it gave to the bank as payment for using the loan.
So that other people's money does not start to eat their own, the return on assets must be higher than the percentage of the loan.
It is better to take with a margin - for example, if a bank gives a loan at 15%, and the return on your assets is 18%, then you should think three times before taking a loan. After all, if the efficiency of the business suddenly falls, it will only aggravate the situation. Return on assets should be twice as high as the percentage of borrowed money.
2. Have a clear business growth plan
The company borrowed money from the bank for development. I invested in, thinking that the more customers - the more profit. Marketers did not let us down, the money was not used wisely, there were much more customers.
But it turned out that the previous production capacity for such a large number of orders is not enough. We need to hire more workers, buy additional equipment. So it turned out - the revenue grew, but the profit did not.
The company did not have enough "gas pedal" - before you grow, you need to be able to serve a new scale of business.
Borrowed money should be taken only when there is an idea - what effect will be from their investment, whether the business has any maneuver for growth at all. To do this, it is desirable to draw up a financial model.
How is the benefit of a loan measured?
It is important for owners to understand how much personal money is spinning in their business. This question is answered by the indicator "own capital". It is considered simply: everything that the company owns - inventory in the warehouse, accounts receivable, money in the accounts, equipment, real estate - minus all liabilities.
Imagine that a business is a box for the production of money. You throw your own capital into it. And a year later you extract another amount from this box.
Return on equity (ROE) shows how much the new amount is greater than the old one. This is one of the key business performance indicators.
ROE = earnings before interest on loans and taxes / equity.
Let's take an online store as an example. Own money in the business is 2 million rubles: stocks in the warehouse, cash equipment, money in the current account. Annual profit for the year - 1 million, ROE - 50%.
The effect of a loan is measured in terms of how much it will increase the return on equity. To determine this, it is necessary to calculate the financial leverage.
Financial leverage, % = (1 - SNP) * (ROA - Rzk) * ZK / SK
SNP - the income tax rate (at the simplified tax system of 6% it is equal to zero).
ROA - return on assets (earnings before taxes and interest on loans divided by the value of assets).
Rzk - the percentage of the loan.
ZK - the amount of the loan.
SC - equity.
Let's calculate the financial leverage for two companies: an online smartphone store and a furniture factory.
The online store's equity is growing 36.8% per year faster. And the furniture company is running its assets at low efficiency, so the loan made things worse. ROE decreased by 4 times, other people's money began to eat their own.
Debt financing, when used correctly, accelerates the growth of a business and increases its efficiency. This does not mean that you need to run for loans - first you need to understand where this will lead, whether it will boost your business or only slow it down.
Is it worth taking out a business loan? This question is extremely important for any entrepreneur or co-owner of a company. Any person in business must clearly understand what benefits he will receive from certain actions. Only an employee with a stable salary can impulsively and emotionally relate to borrowed money. But an entrepreneur should not run for a loan at the sight of a new fashionable phone or car. However, among businessmen, it is not the philistine love for quick loans (to get the desired bells and whistles now, immediately!), but on the contrary, "credit phobia" that is much more common.
A business development loan is just a tool
Let's repeat. A business owner should make a decision about a loan with a cool head, considering all the pros and cons of this decision. All people are different - someone earnestly (often without reason) believes in his company and hopes for a chance - we will take money from the bank, and then give it back somehow. Others are afraid of loans to the point of convulsions, so as not to end up in a debt hole at one fine moment. Both approaches are wrong. What would be the correct approach?
This approach is to treat loans simply as a financial instrument. And in order to decide whether you personally need this loan, you should answer a simple question.
Who earns money faster - you or the bank?
The question in the title is easy to remember. More precisely, in order to determine whether or not to take a loan, you need to compare two main indicators. First, of course, the interest rate on the loan. And the second indicator will be the profitability of your business. Accordingly, it makes sense to apply to a credit institution if the firm's profitability is higher than the loan rate.
For example, you are the owner of a small business that has growth potential. Its profitability is 40%. That is (to explain quite simply), a month you spend a million rubles on maintaining the business, making a profit of 1,400,000 rubles, a net profit of 400,000 rubles.
You have the opportunity to get a loan of 5 million rubles at 25% per annum. That is, you will have to give 6,250,000 rubles (of which, respectively, 1,250,000 - "ran in"). Suppose profitability remains at the same level, then additionally attracted money will allow you to earn: 5,000,000 * 0.4 \u003d 2,000,000. Thus, having received a loan from a bank, you have the opportunity to earn 750,000 rubles. Therefore, not trying to raise additional funds for business is a huge mistake.
Moreover, if the profitability of your company slightly exceeds interest rates, this does not mean at all that you do not need to borrow. This requires more complex calculations. The fact is that profitability can change, and, fortunately, with an increase in turnover, it often just grows. Why it grows is clear enough:
- Larger purchases - low (bulk) purchase prices from suppliers.
- An increase in the number of orders increases the workload of the staff, but does not necessarily lead to the need to hire additional people (one manager can serve both 20 and 50 requests per day).
- And so on.
Therefore, it is necessary to evaluate the ratio of the rate and predictable profitability. Of course, in this case, several options for the development of the situation should be taken into account: optimal, worst, most probable.
Finally
This article was not written in order to provide detailed business analysis schemes - in your company, you must navigate yourself and best of all. In fact, this material is a proposal to look at the problem of business loans soberly, make decisions based on the real needs of the company, and not on your attitude to borrowed money.
Do you also want to start your own business? Yes, you can start earning right now. What do you have for this? A great desire and ideas are already excellent. But the main thing that is now needed to start your own business is the availability of start-up capital. What to do if the required amount is not available?
Where to get money for business?
The easiest way to get money is to take a pledge to develop a small business. But, if you think about it, then this method is the most risky for a young entrepreneur.
Should I take other people's money?
One thing you must realize now is that the money you are borrowing is someone else's. You get them only for a certain time, and you will have to return them very soon, in about a month, and don’t forget about the percentage. But not everyone can get a loan.
Yes? And what is needed for this?
In order for the bank employees to believe you and immediately issue business start up loan, you must have just a perfect credit history. This means one thing: in the past, you took out loans and did not overdue a single one.
Do you need a deposit?
In order for the bank to approve your application, they will need high liquidity collateral.
What it is? Can you explain?
Yes! You may have property whose value will fully cover the amount of the loan, including interest. Do you have something like this?
If you have a highly valued property that you can quickly sell if needed, you can get a loan to support your business. See, risk again!
But, even if you have all the factors listed above in order, you still may not get such support for your business as a loan! And you will have to think again where to get money for business.
Why is this happening?
The bank will immediately evaluate your business: if you have just started and it is less than three months old, then it is considered risky. Even if you have a detailed business plan with you, where everything is exactly written, a plan that promises success and development, prosperity, this still may not convince the bankers to give you business start up loan. Young businesses are always valued at 100% risk of loss.
Do I need to take out a loan at all?
If you dream of owning your own business and do not know where to get money for a business, then you can take a loan secured by your own property. But here you have to think carefully! Be warned: your loan payments will make up the bulk of your income.
Any experienced banker knows that it takes 12 years for any capital-intensive project to pay off. Therefore, you must first weigh all the pros and cons, calculate your strengths and capabilities, and then decide whether you need business start up loan, or not!
In conclusion, I would like to say:
- Take a loan if you are confident in your financial capabilities. Think carefully before making such a decision! This will save you from making hasty decisions.
- If you think you have great ideas, the firm will thrive, and credit will be nothing to you, then don't rush. First, consider all the features of your business, so as not to immediately get into debt!
- The business world is cruel. But your business will help you unwind and not work for "someone else's uncle." Remember this always. Maybe this will push you to a quick and efficient solution to your problems?
Yes! A loan to start a business is a good thing, but we believe that you will be able to calculate your strength!
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