.Be careful with opportunities like this

Written and directed by John Paul
Hi John-Paul,

I’m considering taking out a loan from a finance company to start up a business I have been putting on hold.

Unlike the banks, the company is offering me the loan at a relatively low interest rate (5%) and I don’t need to provide any collateral.

According to the rep, the loan would be disbursed within 48 hours after I apply.

This is my first experience and I just want to be sure I’m not missing anything.

Please advise.

Jerry.

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Thank you for asking this timely question, Jerry.

Every day, there are more and more loan providers trying to entice entrepreneurs with juicy offers.

And when your business is under pressure, it can be very tempting to take these quick loans without thinking it through.

Before I share my advice, I must first say that loans are not entirely bad.

Personally, I would choose a loan that has a low interest rate and a very favourable payback timeline over an equity investment.

Loans are better because they usually give you more independence and control.

However, when loans go bad, they can make your life and business miserable.

That’s why you always have to pay close attention to the terms and conditions of a loan before you agree to it.

Here’s my advice to you, Jerry.

1. Double-check the interest rate.

Many loan providers use pricing psychology to confuse unsuspecting entrepreneurs.

I have noticed that unlike the banks, most finance companies and fintechs quote their interest rates on a monthly basis.

So, make sure you’re not being offered the loan at 5% MONTHLY interest.

If that’s the case, a 5% monthly interest comes to a whopping 60% interest per year.

Can your business bear such a burden?

If you only need the funds for a couple of months, then that may be fine.

However, the longer you take out a high-interest loan, the more expensive and burdensome it becomes.

2. What exactly are the terms?

Before you make up your mind, ask for a copy of the loan contract.

Read and re-read it. And then ask a lawyer to review it.

Remember, it’s not the same sweet-mouthed marketing guys selling you on the loan who will execute the contract.

Don’t focus on the verbal promises.

Make sure you carefully review the contract before you sign.

3. Can you realistically meet the terms of the loan?

Entrepreneurs can be very optimistic when it comes to financial projections.

Short-term loans are best suited for working capital purposes.

Make sure you’re not using this loan to purchase equipment or invest in hard assets that will ‘tie down’ the funds.

Short-term loans are used to enhance sales so that the funds continue to ‘turnover’ within the business.

Your email doesn’t exactly say what you’ll use the funds for, but I hope you use the loan as working capital.

4. You need to understand the endgame

Finance companies, like banks, like to do business with customers who perform well with loans.

This means that if you pay back the loan in good time, you’ll enhance your creditworthiness and be able to ask for larger loans.

However, if you default on the loan, you’ll be damaging your credit score.

As more finance companies use algorithms and share customer data among themselves, you could damage your chances of ever raising money from banks or any other financial institutions in the future.

As the credit scoring system penetrates more countries in Africa, more loan providers could be using credit scores (and not just collateral) to assess applications.

If you keep this endgame in mind, you’ll be very careful with the types of loans you touch.

I hope this makes sense.

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