TIPS BEFORE YOU TAKE THAT LOAN

Onowe Ajulo
5 min readDec 4, 2019

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Various factors have led to an increase in the number of entrepreneurs doing business in Nigeria, Africa’s most populous country. These factors include the desire for work-life balance, a mismatch between the number of job opportunities and the number of qualified applicants, increased internet penetration among others. One of the major challenges faced by entrepreneurs running Small to Medium Scale Enterprises is accessing the required funds to get the business running and to keep it afloat. In more developed economies, commercial banks are considered to be the source of finance for businesses.

However, in Nigeria, many banks are unwilling to give loans to SMEs and even the few commercial banks involved in SME lending give very onerous conditions that most SMEs are unable to fulfil. This has led to the development of what is known as “alternative lending companies.” Alternative Lending Companies usually offer loans to customers via a seamless process that does not possess the bureaucratic procedure customers would usually face in a commercial bank. Loans are available as a source of capital for SMEs within periods as short as 48 hours and with minimum documentation. The agreement between the lender and the borrower is often evidenced in an offer letter and loan agreement and once this agreement is signed, certain obligations begin to arise on the part of the borrower.

With this ease of obtaining funds comes the challenge of ensuring that this money being collected is truly required by the SMEs. Sometimes SMEs are tempted to see loans as an easy solution to their problems of finance but in actual fact, loans always come at a cost, in other words, loans are not free money. It is therefore important as a business owner to ensure before you apply for that loan that you have sufficiently considered all important issues. How much do you know about borrowing? How much do you know about the business for which you are taking the loan? The answers to these questions should form the basis for your decision on whether or not to go for a loan.

As an entrepreneur, you may urgently require additional funding but it is important for you to consider certain key issues before you decide to opt for a loan from an alternative lending institution. In this article, we would be discussing the key steps to take to enable you to avoid the legal costs, health issues and reputational loss that can arise when you fail to make payment at the time or in the manner that the lender requires.

1. Do a cost-benefit analysis

Before you take a loan, estimate the return on investment on the product or line of business you desire to begin or expand. Cost-Benefit — Analysis is the comparison between the cost to be incurred on the project and the benefit to be derived on the project. As a business person, you should understand that your interest cost is one of your expenses and it should be paid from your profit and not from your capital. So, the question is “can my profit take care of my interest cost?”

The next thing you should do following this calculation is to compare the return on investment to the interest rate. Where the return on investment is lower than the interest rate, it may not be advisable to take the loan in question. However, if the return on investment (benefit) greatly exceeds the interest rate (“cost), then it may be safe to enter into the loan transaction but only after you go through the other steps.

2. Think about the risk in your proposed business

It is important to assess the risk of the product or service that you intend to use the loan sum for. Is it a business and industry you understand well? Have you conducted a feasibility study? What are the key risks in the business and how can you manage them? As a general rule, it is not advisable to take loans for new products or services because you do not yet understand the terrain of the business and where the business is unsuccessful, you will not only face the pain of the wasted effort but also the pressure from the lender. It is advisable that you start your new business with equity capital ( Capital derived from family, friends or personal savings as a contribution to the growth of the business)and not debt capital.

3. Read the loan documentation

This might seem like a “no-brainer” to some people. However, from experience, many entrepreneurs are so desperate to obtain a loan that they fail to read the offer letter and loan agreement which contain the terms and conditions of the loan transaction. It is important that you do the following: study the loan agreement, take your time to understand any terminology used, find out the mode of payment and enquire as to what happens if you are unable to pay.

4. Understand key terminology and implications of same

For the sake of emphasis, it is very important that you understand the terminology used in the loan transaction and the implications of any words you do not understand.

For example, do you know who a guarantor is and his/her responsibilities under the loan transaction? A guarantor is simply a person who will be held accountable for your debt if you are unable to repay within the required time. Guarantors commonly co-sign the loan agreement and subject to the company’s terms, will be held responsible upon default by the borrower either in payment of interest or payment of the principal or both. Thus, it is important to ask yourself, “ if this business fails, are my guarantors people that can support me or will they add to the pressure I will be facing from the lender.”

If you are a guarantor, you should also be aware that you are as liable as the borrower itself in case of default or inability of the borrower to pay. In other words, don’t just guarantee a loan and go to bed, remember than the tension of recovery is beyond the loan procedure itself.

Another key term you should look for in your loan documentation is “default”. Under the loan agreement you desire to sign, when does a default occur? Does it occur only when monthly interest is not paid or will it arise at the end of the duration of the loan? What are the consequences of default?

5. Alternative source of repayment

Working with the worst-case scenario analysis, you must consider if alternative sources of repayment exist. This becomes very important, especially where entering into a new business line with many uncertainties. To guard against the pressures that come from lenders it is important to ensure that there is an alternative source of payment.

There are many things to consider when taking a loan but the five (5) listed above are the major points. Take note of these to ensure that you avoid the costs (legal and financial), health issues and reputational loss that can arise due to your ignorance of payment expectations from the lender.

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Onowe Ajulo

Lawyer in Africa sharing my thoughts on life, law and business.