2025 Small Business Owner Guidelines for Capital Expenditures
How does a savvy business owner project debt service?
It’s imperative to estimate the interest rate until the loan closes
The key question is: How Much Does It Cost?
The Federal Reserve Bank recently announced that in the coming year they will evaluate the Impact of inflation before considering any change in what they charge for interbank borrowing. The Fed had intended to make four rate adjustments in the coming year, and everyone had anticipated that rates would drop. But the Fed now says they will consider only two possible rate adjustments. Consumers will have to determine if they have available income to cover the forecasted rates for a home, a car, or other major purchases. Business owners must evaluate how this announcement will impact profitability.
How does a savvy business owner project debt service when he or she is unable to determine an interest rate until the loan closes? The following information will provide guidelines for small business owners who are considering capital expenditure for growth in 2025.
Review loan documents carefully before signing
Commitment letters drafted by lenders in times of market uncertainty will not fix an interest rate for a loan until the date of loan closing. Interest rates will be shown as a differential between the lender’s costs of funds and the rate to be charged to the borrower. In addition, the loan documents may require periodic rate adjustments during the loan term.
Maintain qualifying personal credit scores
Be certain that all shareholders who own 20% or more of the shares of the company maintain good personal credit scores from the three major credit bureaus: Experian, Equifax and TransUnion. A good personal credit score results in the most favorable interest rate offered for the type of loan that is requested. The company CEO should require periodic updates of credit reports to assure that personal FICO scores of 680 or higher are maintained. If a shareholder has a low credit score, that individual should not own more than 19% of the company’s stock. But any adjustment in percentage of ownership positions should be made at least 6 months prior to seeking funding from an institution. If necessary, an adjustment in compensation can compensate for an ownership reduction.
Prepare pro-forma income and expense projections
The financial projections should reflect both best case and worst-case scenarios. The proformas should be reviewed quarterly to include all current changes in both income and expenses. and debt service. The adjustments should include seasonal sales adjustments, and appropriate payroll and insurance adjustments. If the worst-case scenario projections provide an acceptable profit margin, there is a strong possibility that your loan request will be considered favorably.
- Examine existing leases and other debt obligations.
- Make the appropriate annual adjustments in the rent and pass through the operating expenses. Also, analyze all existing debt obligations that have variable rates.
- Consider the salaries paid to principals
- Defer any increase in owners’ salaries until the cash flow projections reflect available cash after debt service payments.
Other considerations…
- Seek a lender that offers a favorable fixed rate. If the loan doc requires periodic adjustments, it is preferable that they be annual or quarterly, rather than monthly.
- Long term debt may be your best option, if there is a reasonable prepayment penalty. It is best to have the option to pay off the loan prior to loan maturity.
- Always evaluate the actual loan costs, including all up-front fees, annual fees, late fee charges and penalties.
- High-rate lenders usually offer favorable entry terms, but severe penalties. Can you afford the risk?
- You will be guaranteed all loans, and this will impact your ability to purchase a home, buy a car, or access capital for personal needs. What are your priorities?
- Reach out to the bank that currently holds your business operating account. If they are not interested in providing financing, you can let them know that you will seek funding from another lender and may have to close the existing account. Banks never like to lose an account.
Do not seek investors until you have shopped for debt. It is usually preferable to obtain third party debt rather than give up a portion of ownership.
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