Are you considering expanding your small or middle-market business to include a second location, and trying to take out a loan to make it financially feasible? Think about it from your lender's perspective: Even if you can demonstrate success at your first location, there's no guarantee that your new storefront will see the same success levels as the first. It's a harsh reality that, as Gallup reports, most small businesses fail within the first five years. No matter how much due diligence you've conducted, banks may be hesitant to loan you money for expansion — and you may be thinking about leveraging collateral for expansion as a result.
Sometimes referred to as an "asset-based loan," this approach to financing gives your lender additional protections, thereby increasing the strength of your loan application. Essentially, you're mortgaging your first location to pay for your second. But, beware: Asset-based loans also increase your risk as a small business owner. Should your second location fail, the bread and butter of your original business may be jeopardized.
If you're thinking about taking out an asset-based loan or leveraging collateral for expansion, you'll want to ask yourself the following questions.
1. What Is the Worst Case Scenario?
As successful as your first location might be, you may not be able to expect your second location to generate the same results. You'll be onboarding a brand new employee base and serving customers in a new geography. This will present a number of new opportunities, but also may raise some new, unpredictable challenges.
Before deciding to put up your first location as collateral, you need to accurately assess your risks. Vet your own analysis and build contingency plans with outside consultants. This upfront planning process will help ensure that you're ready to bounce back should your cash flow take a turn for the worse.
2. What Are Your Assets Truly Worth?
When you're leveraging collateral for an expansion into a second location, your bank will likely need to conduct an appraisal. Keep in mind that these estimations are often very conservative.
That's why it's important to conduct an independent appraisal to evaluate whether the deal you're offered is fair, in case you need to negotiate. Should something go wrong, there's a chance you'll lose the core of your business. You need to be aware of what you're potentially putting on the line when leveraging collateral for expansion.
3. Are You Putting Too Much on the Line?
Sometimes, lenders will ask to secure more collateral. You may have additional resources on your balance sheet, for instance. You need to make sure that you always have a contingency plan to protect your core business. Make sure the loan you receive is fair and will protect you against unforeseeable future changes.
Talk to multiple loan providers and fellow business owners, and only pursue an asset-based loan after careful consideration.
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