Consider The Complications and True Cost of Bank Loans

I am an advocate for small businesses, such as broadcasters and media firms, to establish and build a good relationship with your local bank. Typically that means getting to know a senior officer at the headquarters or local branch, and more importantly, helping them get to know you and the nuances of your particular business. Sometimes this is difficult. Large banks tend to rotate officers. Nonetheless it pays to have a relationship with a local banker for depository accounts such as business checking and savings and for your personal accounts as well. The more they know you, and trust you, the better positioned they are to help you with working capital, operating lines of credit and business acquisition lending.

An important consideration when seeking bank financing for equipment is "what is the real cost" of the borrowing? One advantage that bank loans may have is that they are often "simple interest" loans which means you are only charged interest for the time you have use of the money. This is important if you plan on borrowing but expect to pay-off "early". For instance you might take out a loan with payments based on 36 months, but you expect to pay it off in the first year. A bank Simple Interest loan may be an attractive solution. However, it is important to keep in mind that bank loans often charge loan administration costs that inflate the actual financing rate. A typical bank loan might offer an interest rate of Prime + 1% or 2% or 3% (currently 8.5%, 9.5% or 10.5%) for an average small to medium sized business. Remember that if these rates are "floating" you bear an interest rate risk if the expectation is that market rates will rise over the term of your loan. Banks often charge an annual fee to administer the loan every year that the loan is active. This fee may be 1% or 2% or 3% of the loan. Don't forget to factor that in to your interest rate. It could change your "Prime+0%" loan into a Prime+3% very quickly. Banks also want you to keep money in your account and they probably are not going to pay you the maximum return you could earn elsewhere. These required deposits are called "compensating balances". The bank probably won't ask you to pledge an amount equal to the loan but remember that if you fall delinquent on your loan the bank could attach your deposits. Another factor that banks use to control or mitigate their lending risk is to write loan "covenants" into the language of your loan documents. Loan covenants are usually restrictive and written to the benefit of the bank and often create limitations on future borrowing, such as you cannot borrow from anyone unless you obtain the bank's approval. They also often include "milestones" whereby if your business doesn't achieve certain levels of financial performance the bank can "call" the loan (meaning you must repay it immediately. I recommend that when considering a bank loan for equipment, technology or systems integration projects you consider the cost and the impact on your business of the bank loan, then compare and weigh a non bank financing. You may be surprised to find that often you can achieve lower financing rates with an bank owned financing or leasing company that specializes in equipment finance but without the restrictions, limitations or involvement with your business.