What the right cost of funds should be for any given deal is always an interesting question to ponder. Business owners will get a certain interest rate or rate of return locked into their mind and won’t settle for anything less. If they have properly gauged the market, this can be a good strategy, provided you have time to beat the bushes for the best deal.
In reality, however, every business financing scenario where a debt lender or investor extend money to a business for some application is a customized solution. No two are the same and at any given point in time there can be radical departures among what is available in the market for otherwise seemingly similar deals.
Sometimes you get lucky and step into a rate that would not typically be available to your business and the desired application of funds. Sometimes you’re not so lucky and its hard to find anything where the cost of funds is what you would consider reasonable.
So what is the right answer in terms of when is the cost of capital too high?
Assuming you have properly approached the market with your financing requirements, the appropriate cost of funds, at a given point in time, is what you cash flow.
If you must have money right now for operations, expansion, survival, etc., then you need to determine if you can cash flow the best available deal in the market. If you can’t, don’t take the dough. And when I say cash flow, I don’t mean come up with a forecast based on some low probability assumptions. If you can’t debt service the financing proposal on a cash flow projection with at least a 70% probability of success, then the cost of money has gotten too high.
No one wants to pay more than they need to at any time. But business financing is very fickle and even more unpredictable, so some times the deal is better than others.
The main objective is to make decisions that will allow you to fight another day versus the alternative.
If you’re too focused on securing a low cost of financing, you could run out of time and blow a good deal. If you take on financing that can’t be cash flowed within reasonable certainty, you may very well have sold the farm.
The point here is don’t get hung up on interest rates or rates of return, get hung up on cash flow and time lines. The longer you stay in business, the more often the cost of money will be in your favor and allow you to bank good returns. Its just not always going be that way, so get used to it and make the best decision today to assure better future opportunities.