Taking Out a Business Loan: How Much is Too Much?
When you request a merchant cash advance or other type of business loan, the most important calculation that you can do is to find out whether you can afford paying the loan. That is why so many of our clients start out conversations with us by asking how much they can (or should) borrow.
When you take out a merchant cash advance, that’s a great way to pay for some big business objectives you have – whether it’s adding staff, buying necessary equipment, enhancing your marketing strategy or other ways to expand your business. But how can you tell what you really need – and what you should wait to fund?
Some of our clients are tempted to take out an advance that is much larger than what they need. They have good intentions – they want to build a “rainy day fund” just in case the expansion they have in mind does not work out as quickly as they had planned. However, while merchant cash advances are quick and convenient, they do come with a fairly sizable fee (Between 20 and 40 percent of the advance, depending on your risk profile). So taking out a lot more than you need leaves you with more money in your bank account, but it also leaves you with a lot more expense on the financing end than what you needed to pay.
Some of our clients end up with the other problem, though – they don’t take out enough. They don’t take into account all of the costs of growing a business. They might think about the costs of acquiring physical space, but they don’t think about how they will have to pay larger utility bills and a heftier property tax bill as a result. They might not consider how many people they actually need to hire in order to make the expansion work.
Here’s one reason why it’s actually better to err toward not taking out enough when it comes to merchant cash advances. Let’s say that you put together a strategic plan for your business’ growth and you determine that you’ll need $75,000. You are approved to take out $100,000 for your advance. Instead of taking out the whole $100,000, though, you might consider taking out $80,000 – that gives you a little bit of a cushion without the added expense that would come with borrowing the full $100,000. If your fee is 25 percent (meaning you are a relatively low risk), you would only have to pay $100,000 back over the next nine or ten months ($80,000 + 25 percent) as opposed to $125,000 ($100,000 + that same 25 percent). That is a fairly significant difference, and if you find that you need the extra money later, a reputable firm will let you come back and add to your advance – and only charge you the fee for that added money instead of making you refinance and start paying an entire new fee.
If you’re worried about not having enough out with your initial merchant cash advance, it’s important to remember that you only pay back the percentage of your revenue each day that you and your lender agreed would make the most sense. So if you have a huge month, you’ll make a larger payment than you will during a lean month, but you won’t end up under the gun if you have a slow month. The money you’re still bringing in can augment some of your advance – if you’re having a flush month – and go toward your growth as well.
When you’re putting together your thoughts for requesting a merchant cash advance, you want to think both in the present and the future. Take a long look at your strategic plan for your business and make sure you’ve accounted for all of the costs – and all of the revenue that your company will continue to bring in – before you apply for a particular amount. Over time, you’ll find that requesting an amount closer to what you need, without an unnecessarily large cushion, will make the difference between getting the infusion that you need and overpaying in financing expense.