There are 2 primary ways to fund a business. It’s very rare a stranger will just come along and gift you a bunch of money with no strings attached, right? So how should you fund your business?
- Equity – This is when you have a partner(s) or other owner(s) act as investors with no guaranteed return. They share both in losses and profits. That means that if you have a $2,000,000 net in your 5th year and they own 40% of the company, guess what: they get $800,000. Even if they only invested $20,000. Normally the allocation of profits and losses are proportional to the percentage of ownership.
- Debt – This is a loan of any kind, from a bank, credit union, loan fund, any other financial institution, or another person. The biggest difference between debt and equity is that you owe your creditor before you make any money…so even if you don’t make enough to cover your loan, or enough to pay your loan AND you regular business expenses, you still owe your creditor that money. You pay no matter what, at a fixed payment rate.
So why does anybody get a loan? Well, have you ever heard “you shouldn’t get a loan unless you already have the money?” That’s all well and good, but what do you do if you have a great business plan, the skill to make it work, but no cash? Sometimes you just need help.
This article is written to help you navigate the murky world of trusting your lender. Simply put, this article is a warning. A fairy godmother of advice. It’s also meant to scare you a little by saying BEWARE OF PREDATORY LENDERS.
Here’s an example: you get a letter in the mail. You’re pre-approved for $15,000 at a rate of between 12.99-24.99%. Hmmm…guess where your interest rate will probably land. Well, let’s see. If you pay 24.99% on $15,000 over a period of 48 months…you’ll end up paying $23,869. Whoa. And that doesn’t include closing costs, documentation fees, origination fees or “points” on your loan.
Or take a look at this quote a client brought to us from a predatory lender below, where they wanted over $48,000 just to issue a loan for $400,000. Their loan should have had less than $10,000 in closing costs, not $48,000.Predatroy Lending Example
Do not get fooled by people telling you that “your credit is so bad this is the best rate you’re going to get.” Please, please shop around. “Predatory lending is any lending practice that imposes unfair or abusive loan terms on a borrower. It is also any practice that convinces a borrower to accept unfair terms through deceptive, coercive, exploitative or unscrupulous actions for a loan that a borrower doesn’t need, doesn’t want or can’t afford” (Debt.org).
Abusive terms come in the form of high interest, prepayment penalties, bait-and-switching your terms at signing, high fees, and so much more. Some states don’t regulate as strictly as others, so you can bet those amazing pop-up ads on your computer for online lenders “Cash quick, pre-approved, AMAZING!” are from some of those less regulated states.
If you think these pop-up ads sound too good to be true, then you’re right. For tips on how to educate and protect yourself against predatory lending, read ” Predatory Lending, Part 2: Finding a better Alternative with CDFIs.”