How do I compare two business loan offers?

The five figures

For each offer, from documents rather than conversation:

1. Cash received — amount funded minus everything deducted at funding.
2. Total of all payments.
3. Cost — line 2 minus line 1.
4. Outflow per month — weekly payment x 52 / 12, or daily payment x 21.
5. Months to clear.

Then one rate for each, computed identically: solve for the periodic rate that makes the payments equal the cash received, and multiply by periods per year.

Worked on two offers

Illustrative only — both offers are for $45,000.

A is cheaper by $3,369.84 and takes three times as long. B is gone by month eight and takes $5,352.91 more out of every month while it lasts.

The two things the numbers miss

How to decide

Apply the affordability test before the cost test. Work out free cash flow from your worst three months in the last year, subtract existing debt service, and see which outflow figure fits with room left over. Discard whatever does not fit, whatever it costs.

Then, among the survivors, take the lowest cost per dollar of cash received. In the example, that is A at 19.9 cents per dollar against B at 27.8 cents.

Two more things to insist on: a written fee list in dollars, and a payment schedule you can put into the calculators yourself. If either is missing, you are comparing one offer to a description. The longer version of this method is in how to compare two offers with different structures.

The affordability test, run on these two offers

Here is that test with the numbers in it.

Offer A demands $2,203.34 a month, leaving $3,196.66 and covering the payment about 2.45 times. Offer B demands $7,556.25 a month, which is $2,156.25 more than the business generates in a bad month. Offer B is not expensive. It is unaffordable, and its lower total cost is irrelevant because the business cannot reach the end of it.

That is the order the test runs in: affordability, then cost per dollar, then everything the numbers do not cover.

When one offer has no fixed term

A percentage-of-deposits or percentage-of-card-settlement structure has no contractual end date, so it has no single rate. Do not pick one and pretend.

Compute it twice — once at the funder's assumed speed and once at a speed 30% slower — and carry both figures through the comparison. The slower case is the one to test affordability against, because the outflow lasts longer. The faster case is the one to test cost against, because the same fixed dollar cost compressed into fewer weeks is a higher annualised rate.

If the funder will not give you the assumption behind their estimated term, that is the answer to a different question.

Comparing a line to a term loan

A line and a term loan are not comparable on total cost, because a line's cost depends on how much you draw and for how long.

Build the line's cost from your own drawdown plan: the interest on the balance you actually expect to carry, plus the unused-line fee on the rest of the commitment, plus any annual or draw fees. Then compare that annual figure against the term loan's annual cost. Do it twice, at your expected utilisation and at full utilisation, because the lender will underwrite the second case and you will live in the first.

What to demand in writing before you compare anything

1. The exact amount that will reach the account, after every deduction.
2. Every fee, in dollars, with the date it is charged and what triggers it.
3. The payment amount, frequency and count.
4. The prepayment position — whether early repayment reduces the cost, and by what formula.
5. The security package: guarantee type, UCC scope, any deposit account control, any confession of judgment.

Two offers described in conversation cannot be compared. Two offers on paper can be compared in fifteen minutes.

What the prepayment clause is worth

Point four does more work than it looks like it does, because it can reverse the ranking.

On amortising debt, early repayment stops interest accruing, so a borrower who expects a strong quarter should price the offer at the term they actually intend to run, not the contractual one. On a fixed-total product there is nothing to stop: the obligation is a dollar amount, and repaying it in four months instead of eight doubles the annualised cost rather than halving the bill.

Some fixed-total agreements do write in a discount for early retirement. Where one exists, read the formula rather than the headline. A discount stated as a percentage of the remaining balance is worth far more than one stated as a percentage of the unearned cost, and a discount available only in the first thirty days is worth almost nothing. Ask for the payoff figure the agreement would produce at month three and at month six, in dollars, before you sign it.