There is little argument that if you can double your agency’s premium book, the inherent renewal economics will more than double income. The first question is; how do you grow to double your premium book? Keeping in mind that the growing comes before the doubling, you have to figure out how to pay for the doubling.
For instance, if you want to buy a lead generation facility and back office software for, say, $25,000, then you have to pay attention to the question, “where does that money come from”. On a larger scale, perhaps there is a book of business that fits well with your current products and you can pick it up for $275,000; more dollars, same problem. So where are those dollars? If they are not in your bank account, then they come from either debt or equity.
We all know what debt is, or do we? And equity; what’s to know? You go to the stock market and buy shares, that’s equity. The fact is, there are different kinds of debt and different kinds of equity. If you are an agency that wants to grow your business, then it is well worth your while to find out about debt and equity.
This discussion focuses on the debt side of the funding for growth question. A second discussion examines equity.
Borrowing is a risk, and there is no doubt that rational borrowing for successful growth is well worth that risk. However, borrowing from family, from a bank, or the secondary money market are very different. For one thing, in addition to costing less in interest, it is very likely that a family lender will be much more forgiving than, say, a bank, not to mention the secondary money lenders. In fact, the one thing these commercial lenders will have in common, and quite apart from family and friends, will be a requirement for collateral in some form. In almost all cases, it will be necessary to back up your loan with your house, your car, your business equipment. These are hard assets, which is why such loans are referred to as ‘hard money’ loans. That is, taking on a hard money loan means that you are betting your assets on your ability to repay that loan according to its terms.
The loan we all know about is the amortization, known in more familiar terms as your home mortgage. Here, you agree to pay back the sum of money, say $225,000, in a fixed number of payments, each payment in the same amount, at a specified interest rate. For example, if your $225,000 mortgage loan is to be repaid over 15 years at 4%/year interest, you will make a monthly payment of $1,664 per month.
Then there is the balloon note. Here is a simple example; you borrow $225,000 and will make no payments for say the first 2 years, then the entire $225,000 plus accumulated interest is immediately payable. It will probably be more expensive interest-wise; say 10.5%. Therefore, two-year’s worth of interest will be $3,938, so at the end of the second year you have to come up with $228,938.
A third loan type is a compromise between these two. It requires you to pay interest only for some period, and then amortizes the loan balance over a second period. So $225,000 over a 2-year interest only period followed by a 3-year amortization would look as follows, assuming a 12% annual interest rate:
Interest-only period; 24 months at 12%/year = $2,250/month
Amortization period; 36 months at 12%/year = $7,473/month
As you might expect there are innumerable variations on these three themes.
The Collateral Problem
If you are on really good terms with your bank, have stellar credit and little or no credit card debt, you may be able to come by a signature loan. This means the lender is not specifying what hard assets will ensure the loan’s repayment. Instead, you are personally responsible for it. If things go bad, you are on the hook, and the lender will most likely come after you. That circumstance is just as ominous as it sounds.
If a signature loan is not in the cards, then you have to look to your hard assets.Since your home probably has a mortgage, that is not a good candidate for a hard money loan.
How about the building that houses your agency? Only if you own it, of course, and if it is not already encumbered. Which leaves your business equipment. Is there enough there to back the $225,000 note of the example, especially after the note and the equipment have aged a few years?
The fact is, most small businesses do not have the hard assets necessary for a business loan of even modest proportions. So where does that leave you? The answer has to be your soft assets, that is, your receivables.
A lender making a loan against future income is willing to risk that the income will, in fact, turn up when it is projected to. If you provided a service, for instance for legal work for a property closing, and you invoice for your fee, there are funders available who will either buy that invoice at a discount or lend a sum against it. Similarly, if you have a book of policies in force, there are lenders who know how to evaluate that book as viable collateral for a loan.
Unfortunately, there aren’t many willing to use your book of business as collateral, and those that will still want your personal signature on the agreement ‘just in case’. Which is to say, your soft assets are backed up by your hard assets.
Being in business is intrinsically risky in and of itself. You are the agency owner, and it either works or doesn’t work because of you; the buck ends up on your desk. As suggested above, borrowing is a bet on the value added as a result of the borrowing. If the value added turns out to be less than the cost of the borrowing, in all likelihood the borrowing costs are going to outlive any consequent value. But given that the goal is worth the wager that borrowing represents, make a wise risk choice. The following is a ranking from least to most risk:
Family and Friends: Probably the least costly and the most forgiving.
Banks: You will need collateral but that requirement may ease somewhat if you are a long term business customer with a good history and good stats. In this case you should be able to get decent terms for an acceptable amortization.
Secondary Money – Balloon Note: The balloon note is always tempting, but you have to keep your business eye on that balloon date. At first it looks far off on the horizon, but don’t let yourself get into the position where you open your agency’s doors one morning to discover it looming over you. If that happens, you have probably lost the borrowing bet.
Secondary Money – Interest Only + Amortization Loan: The interest only period provides the breathing space to realize on the value that the borrowed funds provide; e.g., 6 months of hiring and training plus a year and a half to significantly increase sales that produce commission income well beyond the interest expense and subsequent amortization payments.
Taking on debt to grow your agency is definitely a risk. The majority of agency owners will have to look to the secondary money market for debt financing. Generally speaking, that will call for collateral, so in all likelihood you will need to find a lender who will consider your books of business as collateral; better yet, a lender who will look only to your books of business and not require a personal signature.