Short-Term Loan Solutions

Securing a succession of small loans can help you cover expenses while building revenues

By David Newton • May 5, 2006 Originally published Sep 9, 2003

Opinions expressed by Entrepreneur contributors are their own.

Can a business borrow some money for the short-term to helpcover expenses while building revenues? Yes, and the way to do thistype of deal is to secure three or four investors to lend yourbusiness funds as part of an overall one-year to 18-month plan. Thebig picture is that this format is really a series of short-termloans perfectly sequenced to fit end to end. There are manycompanies who have used this successfully to keep cash flow flowingwhile they build and implement the firm's sales and marketingplan. The first four or five monthly payments can actually be madefrom the proceeds of the loan, provided there is a successor loanset to kick in on the back-end of each credit extension. And ownersshould understand that each successive round of funding should bean increased level compared to the prior level. There aresignificant risks involved in pursuing this kind of a deal, butthere are also some very attractive potential benefits that buyyour company some time to get established in the market.

Here's how it can work. A company sets up a three-month lineof credit for, say, $35,000 (must be repaid in full in 90 days).The annual equivalent interest at 7 percent is around $2,400, so itcosts about $200 per month "interest-only" for the firstthree months the $35,000 is accessed. The company sets aside $5,000to make a 90-day principal payment that could trigger a 30- or60-day extension of the original terms. This serves as a fallbackposition in case the subsequent second loan is not ready for somereason on the 91st day. The company can now use more than $29,000for operations over the next 90 days, and even without revenue, itcan make the $200 interest-only payments each month and have $5,000set aside to make a principal reduction payment in case they needto keep this line open for another one to two months.

At the 91st day, a second lender steps in with perhaps a $50,000working capital credit line for another 120 days. This loan isfully amortized over the four months and requires monthly paymentsof $12,682 (principal and interest) to stay in good standing. Thefirst month's payment is held in a money market account forthat initial payment due in 30 days. Now the company has use ofaround $25,000 (half the loan) for 60 days until payment number twois due, and another $12,000 for the following 30 days out to theend of the third month. By then, the firm will have secured a fewearly sales on its marketing plan, and a few of these will havealready been collected and can be used to pay for some operationsitems.

New sales are then stockpiled toward the final $12,682 paymentthat fully retires the loan, and the third short-term loan is thenset to begin. This time, the company now has two positive creditratings on its record and qualifies with another line for $100,000and a one-year term, and perhaps the loan is now structured asinterest-only on a quarterly basis. That requires payments of onlyaround $600 per month, and the firm could hold back one-third($33,000) of these funds to make a "good faith" principalpayment in the fifth or sixth month. This demonstrates to thelender that the company can handle its debt service and principal,and it helps build a very favorable credit rating for the firm.

There are risks, of course. If the firm does not generate salesand any loan cannot be extended, and all the loan proceeds havealready been spent, then the lender will foreclose on the principaland the owner(s) could be personally liable for repayment, orassets pledged as collateral could be seized to repay theprincipal. But these risks are manageable if the owners don'tuse all the funds at each access point and reserve a portion of theprincipal for monthly debt service and/or a "good faith"early principal portion repayment.

David Newton is a professor of entrepreneurial finance andhead of the entrepreneurship program, which he founded in 1990, atWestmont College in Santa Barbara, California. The author of fourbooks on both entrepreneurship and finance investments, David wasformerly a contributing editor on growth capital for IndustryWeek Growing Companies magazine and has contributed to suchpublications as Entrepreneur, Your Money,Success, Red Herring, Business Week, Inc.and Solutions. He's also consulted to nearly 100emerging, fast-growth entrepreneurial ventures since 1984.

The opinions expressed in this column are thoseof the author, not of All answers are intended tobe general in nature, without regard to specific geographical areasor circumstances, and should only be relied upon after consultingan appropriate expert, such as an attorney oraccountant.

David Newton

David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.

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