The Burden of Borrowing Your growing company could be hindered by hidden loan costs if you don't look ahead.

Like many growing companies, Safe HandlingInc., a transportation and warehouse services business inAuburn, Maine, has relied on a range of credit during its 12-yearhistory: funding for equipment purchases, working capital loans andterm debt, often from multiple lenders. While meeting eachcreditor's reporting obligations is time-consuming, the biggerconcern is how these collateral issues could jeopardize futurefunding for the $5 million-plus company. It has even paid off loanbalances rather than allow a lender's requirements to stiflegrowth. "We are mindful of the alternative of paying off alender to maintain simplicity for growth," says CFO BillHowell. "We need to be positioned for future borrowings tofund growth, and we can't do that with onerouscollateralization requirements."

Often, the indirect costs of borrowing, such as burdensomecollateral conditions, have more impact on a growing business thanthe loan itself. A bank may require the borrower to keep a certainpercentage of the outstanding loan balance in an account, forexample, or charge a penalty if any of the loan principal isprepaid. Even firms with straightforward financing needs shouldbear in mind that a variety of factors determine the cost of aloan, not just interest rates and fees a lender charges forreviewing and preparing documents.

While bank competition has given entrepreneurs increasedbargaining power over interest rates, many indirect loan costs arenon-negotiable, including the expense of updating a business plan,paying an accountant or lawyer to meet pre-closing requirements,and providing a lender with ongoing financial reports.

Choosing the wrong creditor is also costly, particularly alender that pulls credit during problem periods. And while acompany may have a loan amortized over a longer period of time forlower monthly payments, the bank may renegotiate interest rates andterms based on the company's performance and otherconditions.

Taking Off theBlinders
For those reasons, experts advise entrepreneurs to not only readthe fine print of a loan agreement, but also consider how it willaffect your company's growth. "It's really theperipheral costs in terms of what that loan takes out of you andhow you're able to manage it that are important," saysSuzanne Caplan, a business consultant with PGM Group LLC."I would not go to three different banks and blithely choosethe one that gave me a quarter point less. I would look at allservices and whether they're going to grow with me."

Companies such as Safe Handling, Caplan notes, are wise toassess the long-term consequences of a collateral decision, whichcan come back to haunt a business in need of further financing."If you've secured a loan with receivables, and yourreceivables grow from $300,000 to $500,000, you're preventedfrom using that as collateral anymore because it'ssecured," explains the Pittsburgh advisor. "It's amatter of 'What does this mean to me now, what does this meanto me three years from now, and am I going to need this collateralback?'"

Meanwhile, focusing too heavily on the direct costs of a loan,such as interest rates, may also lead entrepreneurs to ignore thelegal and accounting burdens of obtaining credit. Along with hiringan accountant to prepare documents, you may also need an attorneyto assist with real estate deals, Caplan says.

The lender's scrutiny won't end with credit approval. Itwill monitor performance, with some creditors going so far asrequiring borrowers to maintain financial ratios related to debtcoverage and working capital. Larger banks, not community-basedcreditors, most often use those formulas. "We're going tolook at the financial ratios," says William Gossett, presidentand CEO of Islands Community BankN.A. in Beaufort, South Carolina, "but it's notformalized on the smaller loans in which you have a borrowingagreement that has [required ratios] in it."

In some cases, a loan is reviewed out of state, making it lesslikely the lender will waive conditions and be as patient as alocal lender. "If your portfolio is reviewed in another state,and they see that [the financial ratios] are off, they may call theloan," explains Caplan. "Sometimes, it may have little todo with what is happening in your business, but whether your folderis complete or financials come in late."

In such situations, the best defense is a good offense:Companies should advise a lender early about any anticipatedcapital needs and deliver bad news swiftly, along with a viableaction plan, says Safe Handling CFO Bill Howell. "The moreproactive you are, the more forgiving [lenders will] be if you hitan occasional short-term critical need."

IncreasingCosts
No matter the nature of the loan, the cost of credit is rising.Collateral requirements are greater in response to tightenedunderwriting standards, says Keith Leggett, senior economist forthe American BankersAssociation, "and there probably has been movement towardlower limits, [such as] loan-to-value limits, which does imply acost because borrowers are having to put up more of their ownequity."

Adding to the cost is the requirement that companies obtainbusiness interruption insurance as a condition of financing."9/11 changed the landscape," Leggett says."Businesses that were not actually by the World Trade Center,but were down below Canal Street, you couldn't get to them, andyou had that interruption. Without insurance, it's going tomake credit much more expensive."

The cost also depends on how badly a bank wants to do business.Deposit levels and whether the company will use other products,such as investment services, contribute to loan pricing. "Mostbanks have formulas where they try to factor in what therelationship is going to mean to the bank," says Edwin Clift,president and CEO of Merrill Merchants Bank in Bangor, Maine."You try to factor that into your pricing formula." Interms of direct costs, most banks charge an origination fee, often1 to 2 percent of the loan amount.

Borrowers also fund legal services obtained during underwriting.For a loan secured by inventory receivables, for instance, the bankhires an attorney to ensure it has a valid security interest in thecollateral, which typically costs a few hundred dollars, he says."Getting into real estate transactions, it may run more thanthat," Clift adds. "If it's a straight real estatetransaction on the building that is going to secure the loan, youare probably looking at legal and documentation fees, depending onthe loan amount, of a couple thousand dollars. And you'll havean appraisal fee of $1,000 to $1,500, depending on the part of thecountry you're in."

Ultimately, a company should use its financial stability asleverage for negotiating other things, such as collateralrequirements, prepayment penalties, interest rates and ratiocovenants, says Howell. "The more profitable and financiallystrong a company," he says, "the more there is theability to negotiate."

Crystal Detamore-Rodman is a Charlottesville, Virginia,writer who covers the small-business finance market.