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Question: I need equipment financing for my animal hospital. Should I get a line of credit or a term loan?
Answer: Should you borrow "short" or borrow "long"? The term of the loan is driven by the term of your borrowing need. You match the repayment plan with the use of funds. Call it the "matching" principle.
In our personal lives, it's simple. You don't permanently finance a home with a credit card. The need--housing--will last for 20-plus years, so a 20-month credit card loan is a dog of a deal. Neither does it make sense to buy your gerbil's food with a five-year loan. The need, the food (and the gerbil) will be gone long before the loan is repaid.
Business is more complicated. A line of credit is intended for short-term needs--for example, to finance a seasonal inventory buildup of flea collars. The line of credit covers a temporary out-of-balance condition and is paid when balance returns; it is based on cash flow, not profit. Traditionally, lines of credit are paid off in full for at least one 30-day period each year.
Lenders will offer medium-term loans for long-term purposes--such as a five-year real-estate balloon note with payments amortized as for a 20-year note. When the note matures, the lender doesn't have to renew the loan. But who knows what real estate or banking conditions will be like five years from now.
Long-term investments require fully amortizing long-term notes with no prepayment penalty. The loan is repaid over time from the profitable operation of the business.
Shed the short-term line of credit. A five- to seven-year, fully amortizing equipment loan sounds purrfect.
George M. Dawson (gdawson@txdirect.net) is the author of Borrowing to Build Your Business: Getting Your Banker to Say "Yes" (Upstart Publishing, $16.95, 800-235-8866). Send him your financing questions at bsumag@entrepreneurmag.com.
