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shutterstock 105421988 Q. I need some money for my small business. I have been approached by a company that will lend me the $50,000 I need. They only want to charge me 3%. I have to pay them back in one month, but as long as I pay my 3% interest on time, there will be no problem extending the loan for additional months. Do you think that accepting this loan is a good idea?

A. Probably not, but let’s explore the situation further. First, you say that they want to charge you only 3%, but that may be a bit deceptive. We suspect it’s actually 3% per month. In other words, if you borrow $50,000 for one month, you must repay $51,500 ($50,000 of principal plus $1,500 of interest). $1,500 divided by $50,000 equals 3%.

You say that it is no problem to get your loan extended for an additional month. If you do that for a year (12 times), you would pay $18,000 in interest (12 times $1,500). However, $18,000 divided by $50,000 is 36%. Therefore, even if you only keep the loan for one month, you are paying an interest rate that is 36% per year. Of course, you’ll never hear one of these lenders say that they are charging you 36%. That rate doesn’t sound good, does it? Nevertheless, that’s what it is. You wouldn’t dream of paying that interest rate for a home loan or a car loan. In fact, most credit cards offer better rates.

The loan you are contemplating is very expensive. In short, almost any other loan you could get would cost you less than the option you’ve described. You could take a second mortgage on your home, refinance your automobile, apply for a new credit card or ask your Uncle John for a loan. Explore all of the other options before taking this loan—it’s probable that any other option would cost you less, most would cost much less.

Another option would be to bring money into your business by taking on a partner—an angel investor. Sell part of your business to an investor to get the money you need. The popular show Shark Tank shows people trying to do this each week. If you follow this route, there are many precautions you should take, but that’s another topic.

Suppose you have no other options. There are no viable investors. You don’t own a home. Your car loans are maxed out and your credit isn’t the best so credit card companies aren’t interested. If you literally have no other options, the loan you are considering might make sense. The key question is how long will you need to borrow the money?

If you will need money for the long term and there is no other source of capital, our best advice is to close down your business. Essentially no legal enterprise can deliver a return of more than 36% in the long run. If your business doesn’t deliver more than your cost of capital, you will eventually go out of business anyway. Facing that fact now will allow you to cut your losses.

On the other hand, if you truly need the money, for only a short time, it may be that such a loan will make sense. For example, you owe your suppliers money. They are refusing to provide the material you need to work until they are paid. Customers owe you money for work you have previously done. What you are owed is enough to cover your obligations and you believe that you will receive payment in the near future. In this case, a short-term loan, even at a very high interest rate may make sense because it allows you to keep working.

Be cautious, there are many lenders that that prey on small business people who have a dream, but are not financially sophisticated. In some cases, the rates are usury. Accepting such rates will cause you to dig a deeper hole in the long run. Nevertheless, there may be situations where these loans are appropriate.

“I HIGHLY recommend Polly and Doug. They have wonderful insight to help small business owners prioritize and identify strategies for growth and improvement. Wish I had met them 20 years ago!”

Sharon MaderePresident / Premier Pet Products

My team and I have had the privilege of working with Polly on our business. Polly's keen business insight and savvy is something special. She was honest, direct, and tactful about her observations and recommendations for our team and how to grow our business. It was a pleasure having her help us and I would tell anyone that’s serious about growing their business to call Polly. She’s great!

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I have known Polly for more than ten years. As an HR Manager, I have utilized Polly’s training expertise at my former company and with my current company. Polly exceled at assessing the needs of our management teams and tailoring training programs that resulted in visible positive change. I also know I can count on Polly as a resource on any HR topic or bounce ideas off of her when I need a second opinion. Polly has been a mentor to me and I have always appreciated her willingness to listen and offer valuable advice and expertise.

Leigh McCullar, HR Business PartnerUniversity of Richmond

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