Cut Your Financing Costs

In for the Long Haul

As a result, many short-term credit consumers have little choice but to absorb the higher interest costs. However, some entrepreneurs also tap those floating-rate lines of credit to fund lengthier capital commitments like buying equipment--a costly financing strategy in today's interest-rate environment. "Occasionally, businesses will have a line of credit and do all sorts of things with the line, not just support their working capital," Page explains. "They'll actually go out and buy a forklift or a dump truck or whatever [equipment] they need."

Fortunately, firms can often transfer those assets to a longer-term loan with a fixed, more favorable interest rate. "Say you had a $500,000 revolving line of credit and [you] used $100,000 to buy capital equipment. You could take that $100,000 out from that revolving line and ask for a separate loan to term it out," Page suggests. "You could then repay it over a three- to five-year period, and at today's rate, that would be a really smart thing to do. A working capital line should support short-term accounts receivable and short-term inventory, and as [you] collect the receivables and sell inventory, the proceeds are supposed to be used to pay the loan back down."

No Knee-Jerking
While business owners are understandably anxious about rising interest rates, experts warn that making a strategic decision--such as whether to upgrade an outdated facility-based only on interest rates can have dire consequences. "If your business is nonproductive due to an obsolete or [undersized] facility, moving to an appropriately sized building to maximize production is always going to be beneficial to the business in the long run. If the business has goals of doubling its sales, but the [current] facility is only capable of producing the sales volume they're at right now, they need to look at expanding," Milbauer advises. "I don't think any business should ever [consider] adding equipment or [make a] decision to grow into a larger facility based on interest rates."

By the same token, commercial borrowers should carefully examine any refinancing deal to determine the actual cost savings. That's because the loan may contain a prepayment penalty clause, which states that if your loan is paid off within a specified period of time--often in the first three years--the lender will charge you a fee. For example, if your loan has a three-year prepayment penalty, the amount of the penalty may be 3 percent of the loan balance if it is paid off in the first year, 2 percent in the second year and 1 percent in the third year. "Before making any kind of a move to refinance, you need to scrutinize the loan documents to see if there is a prepayment penalty," Milbauer cautions. "You [should then] factor in the amount of the prepayment penalty vs. any interest savings to see where the break-even point would be."

Experts agree that you're more likely to get a better deal overall if you solicit proposals from several creditors, not just from your regular lender. Says Page, "The banks are hungry to keep their good assets, so there is a lot of competition among banks. A good, savvy business owner will talk to more than one bank. It's just smart."

Jeff Samuelson concurs: "We had gone to a couple of banks and kind of [reached] dead ends. [The banks] may not have understood the loan fully. We had to get the information to the right banker. And once that happened, everything popped for us."

Crystal Detamore-Rodman is a Charlottesville, Virginia, writer who covers the small-business finance market.
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This article was originally published in the February 2006 print edition of Entrepreneur with the headline: On Good Terms.

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