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Overcoming the High Cost of Funding

Overcoming the High Cost of Funding

Written by Mark E. Battersby | Published May 2024

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The actions of the Federal Reserve have contributed to an increase in inflation and raised interest rates, putting that all-so-necessary funding out of reach for many pressure cleaning businesses. Combine those higher interest rates with leasing and purchase prices essentially doubling in the last few years, and funding the pressure washing business today is extremely expensive and difficult.

First Stop The Bank

With the well-documented reluctance of banks to provide the funds needed by small businesses—and while numerous factors will impact the type of lender eventually chosen—when seeking affordable funding, the best place to begin is usually the bank currently used for the operation’s banking.

Even without a personal relationship with the banker, the bank the pressure cleaning business does business with often has a broader perspective of the operation’s debt, spending, and cash flow. While perhaps only a number in the bank’s system, the operation is already in the system. That puts the pressure cleaning operation one step ahead even with a bank normally reluctant to provide a loan.

Obviously, if a relationship with the operation’s current bank isn’t sufficient to overcome the bank’s reluctance to provide the needed funds—or render advice—a new bank might be necessary. Since banks are often the source for the most economical financing, a community bank might be the answer.

Establishing relationships with community banks is often easy, with them considering the operation as a whole alongside the operation’s cash flow, credit, and collateral factors.

Needs Versus Cost

All banks in general, while not interested in providing long-term funding, provide banking services such as cash management, payroll services, merchant services, and lines of credit. In fact, every pressure cleaning business should already have a line of credit to help tide it over in the short term.

A business’s line of credit provides access to funds up to a pre-set limit, with the business paying interest only on the funds withdrawn. Fees for having the funds readily available are usually competitive.

While banks, even community banks, typically have low interest rates and offer competitive terms, financing may be hard to qualify for. Thus, an incentive such as a guarantee by the Small Business Administration (SBA) might help obtain that needed funding.

The Sba

SBA loans make it easier for pressure washing businesses to get needed funding. The SBA offers lenders, mostly traditional lenders, a federal loan guarantee. This makes it less risky for banks to lend and often means more favorable interest rates and terms for the borrower.

There are a number of SBA loan guarantee programs available, including the following:

• SBA 7(a) loans, the most popular program, provide funds for many purposes and are available in amounts up to $5 million.

• SBA 504 loans offer long-term, fixed-rate financing to purchase or repair real estate, equipment, machinery, or other assets.

• SBA microloans are the smallest loan program offered and provide $50,000 or less to help businesses expand. On the downside, microloans have a high interest rate. The loan is a risk, but short-term delays of new equipment, improvements, or payroll can be riskier. When traditional sources even with guarantees fail to provide affordable financing, it might be time to think about specialized funding.

Equipment Loans

A pressure cleaning contractor seeking funding to help purchase equipment may find the request being viewed differently by a bank because they are lending against a tangible object.

While often more expensive, funding from the manufacturer, dealer, or distributor may be more readibly available. Frequently subsidies, discounts, and/or better terms substantially reduce the overall cost of equipment loans.

Going Online

With the reluctance of traditional banks to lend, online lenders are enjoying a surge of popularity. Best of all, online banking eliminates the cost of brick-and-mortar branches, thereby generating cost savings to be passed on to borrowers.

EVERY CONTRACTOR, DEALER, DISTRIBUTOR, OR MANUFACTURER SEEKING TO BORROW MONEY FACES MANY CHALLENGES, SUCH AS WHERE IS FUNDING AVAILABLE AND AT WHAT INTEREST RATE?

WHAT IS THE TOTAL COST INCLUDING FEES? IS THE FUNDING GOOD FOR AN EXTENDED PERIOD OF TIME, OR CAN PAYMENT BE DEMANDED EARLY? GUIDANCE FROM A PROFESSIONAL ADVISER MAY BE NECESSARY.

Fintech, or financial technology, consists of two areas: interacting with a bank minus the human element and independent lenders working outside traditional banks. Applying for online business loans can be accomplished entirely online.

While online banking is best for those pressure washing operations seeking fast funding and easy applications, under-qualified borrowers often pay extra for online funding.

The Esop Option

An effective strategy for minimizing the cost of the funds needed by the business involves selling the business. An employee stock ownership plan (ESOP) is a tax-effective way to transfer ownership of a small, incorporated pressure cleaning business to its employees while raising the funds needed for the operation’s growth.

With an ESOP the business issues new shares of stock and sells them to the ESOP. The ESOP then borrows funds to buy the stock. The pressure cleaning business can use the proceeds from the stock sale to its own benefit— growth or expansion.

The business repays the loan by making tax-deductible contributions to the ESOP. The interest and principal on ESOP loans are tax-deductible, which can reduce the pre-tax dollars needed to repay the principal by as much as 34 percent, depending on the operation’s tax bracket.

Unfortunately, however, the tax shield does not help with S corporations since they don’t pay corporate income taxes. Capital gains deferral, however, can make ESOPs attractive to these pass-through business entities.

BOOTSTRAPPING AND SELF-FUNDING

Obviously, every business owner should have at least some personal funds at risk to show potential lenders or investors that the owner is committed to the success of the business. Unfortunately, our tax laws make selffunding a touchy—and complex— strategy.

The most basic, affordable funding strategy, called “bootstrapping,” means using personal or family funds to finance the business. Offsetting the convenience of bootstrapping is the necessity for the owner or shareholders to often give up equity in the pressure washing business.

What’s more, whenever a loan is made between related entities, or when a shareholder makes a loan to his or her incorporated business, our tax laws require a fair-market rate of interest be included. If not, the IRS will step in and make adjustments to the below-market (interest) rate transaction in order to properly reflect “imputed” interest.

Borrowers Beware

Dealing with an economical but unfamiliar lender isn’t always troublefree. A loan agreement might, for instance, contain a provision requiring the loan to be repaid if the buyer misses several payments, fails to maintain certain debt service coverage, etc.

Some lenders want delayed payments made up in a single payment, some will modify and extend the loan with minimal paperwork, while others will treat it as refinancing—complete with the costs associated with refinancing. Every borrower should have a clear picture of when the forbearance will end and what the lender intends to do at the end of the loan period.

And speaking of loan terms, as mentioned, every pressure cleaning borrower should match the term of a loan to the life of the item to be financed. If the financing is for equipment, the loan shouldn’t be longer than the expected life of that equipment.

Many business loans differ from other finance requiring only interest payment for the duration. A fixed interest rate stays the same throughout the term of the loan while business loan rates can fluctuate, making them more expensive. At the end of the loan’s term, it means paying off the loan amount in full or refinancing.

Avoid At All Cost

In the search for capital, the easiest options may be the most expensive.

• Credit card debt—Business credit cards often offer more flexible repayment terms but typically have higher interest rates than traditional financing. Designed to appeal to businesses whose cash flow might be irregular, the higher cost of business card debt results because the debt is usually unsecured, making it riskier for lenders.

• Email solicitations—Answering those “We lend money to businesses” ads means leaving the banking sector with its various protections and borrowing from a private lender.

The Added Cost Of Taxes

After funds have been obtained from an economic source at a favorable cost, it doesn’t mean that the interest is automatically tax deductible. There is something called the “tracing rule,” where interest is traced to its use to determine whether or not it is deductible. Suppose, for example, a business borrows money but only a portion is used to purchase needed equipment. The balance of the borrowed funds goes to a key employee or even the owner, allowing them to purchase a personal vehicle.

Obviously, the interest charged on the borrowed funds that were used to purchase equipment, supplies, or other business expenses are deductible. The interest on the portion of those borrowed funds distributed to an employee or the operation’s owner as a loan or bonus is not tax deductible by the borrowing pressure washing business.

Every contractor, dealer, distributor, or manufacturer seeking to borrow money faces many challenges, such as where is funding available and at what interest rate? What is the total cost including fees? Is the funding good for an extended period of time, or can payment be demanded early? Guidance from a professional adviser may be necessary.

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