Borrow Now Even If You Don’t Need To

Most people know to buy health insurance when they’re healthy and life insurance when they’re young. But do jewelers think of borrowing money when interest rates are low and the industry is experiencing one of its longest growth cycles ever?

Apparently not, based on a recent poll we conducted. Of the 130 jewelers responding, only 48% said they were borrowing money. And only one of these had a line of credit with a bank.

“That’s a major mistake,” says Mark Hogeboom, chief financial officer of James Avery Craftsman Inc., a 30-store jewelry retailer in Kerrville, Texas. “Right now, when the jewelry industry is having good times and interest rates are low, jewelers should build and test their banking relationship. Use that relationship so that when you need the money to survive it’ll be there.”

Remember those 18% rates? Though the industry has been so robust recently that many jewelers have had no need to borrow money, Hogeboom’s warning is serious. “There won’t always be good times in our industry, or any other one for that matter, and we won’t always be at interest rates that run between 5% and 8%,” he says. “It’s difficult to convince people—when we’ve had a run of over five years of very good times—to remember how bad it got when gold and silver prices and interest rates took off simultaneously. When interest rates hit 18% in the late ’70s and early ’80s, a lot of family firms were lost because they couldn’t even borrow money at those rates.”

Joe Romano, president of the Scull and Co. consulting group, concurs. “Borrow the money even when you don’t need it,” he says. “Build a relationship in advance of the time you need it.” He recommends that jewelers in a growth situation maintain both a line of credit and a term loan. But, he says, there’s widespread confusion about how each should be used—even among bankers.

Lines of credit, term loans. A line of credit is designed to cover short-term cash deficits in the annual operating cycle. It should be in place even when you don’t need financing. You build a credit history through the line, even if all you do is place the funds in a savings account at another bank and pay the line back in full and on time. It’s a flexible, low-hassle way to borrow money that’s renewable from year to year without the need to renegotiate terms and fees.

But use a line of credit sparingly. “We’re in a low interest rate environment now, but if you have to pay the line of credit back in a higher interest rate environment, it could be problematic,” says Hogeboom. Most banks require a 30-day period during which the line of credit is paid in full.

Another caution: Don’t use the line of credit for inventory. Romano calls that a “trap,” because if you’re unable to pay the line off within the year through profits on that inventory, you dig yourself deeper into debt. “That’s an evergreen loan that you end up financing through profits, trade debt, and memo merchandise,” he says.

The term loan, on the other hand, is a ticket to growth. You can use it for inventory, working capital, store refurbishment, or major equipment purchases. “The term loan allows you to pay the bank over a more comfortable period of time and provides the peace-of-mind money that you need to build your business,” says Romano. After all, significant investments in a company’s long-term growth typically take longer than a year to pay off.

Pursue your dreams. Jewelers too often make decisions about long-term growth “based on the size of their bank account,” says Romano. “If you see an opportunity to double your volume in five years yet don’t have the money to do it, you’re inclined to think it’s impossible to do. Partner with the bank, so that when the money is needed, they’ll help you reach those goals.”

Another recommendation: Establish ongoing business relationships with more than one financial source. That way you can compare rates, service charges, payback periods, collateral required, customer service, and reporting requirements. The jewelers JCK polled are taking this approach, but only to a limited degree. All of the jewelers who borrowed funds in the last year obtained funds from a commercial bank. Of those borrowers, 67% used the bank as their sole source of funds. And less than half (43%) said they shopped around for the best terms and rates.

Some of the other sources of funds used by JCK respondents were hazardous to their personal financial health (see table above). Some 9.1% of borrowers used a personal credit card, 4.5% used their own money, and 1.5% obtained a home-equity loan. “Your house shouldn’t be on the line,” says Romano. An exception might be a short-term bridge loan during the two-year period needed to build a credit history to obtain a term loan.

Another source of funds, vendor financing (used by 4.5%), also carries a risk, says Hogeboom. “Vendors are currently financing a lot of inventory because interest rates are low. But when interest rates pop, vendors won’t be doing the financing, and the smaller stores won’t have the internal cash flow that they’ll need to then establish new banking relationships for the future.”

Now’s the time. There’s an upside to borrowing funds now. Consolidation in the banking industry has created a opportune environment for firms that need capital, according to Hogeboom. The reason: Loans are considered an asset in the banking industry, and the newly formed mega-banks are trying to build their asset base by aggressively wooing borrowers.

However, “These relationships require work,” adds Romano. You need to prove you can repay the loan. You must demonstrate the business acumen and financial and security controls needed to address bankers’ classic concerns about the jewelry industry. Many don’t understand the cyclical nature of the business. They’re concerned about the portability of the inventory. And they find it hard to understand the extent to which jewelers plow revenues back into the business rather than taking profits.

Banking consolidation also means that personalized relationships with lenders will become a thing of the past. “Jewelers used to know their banker personally,” says Hogeboom. “Now you have to build a financial relationship in writing. Don’t try to build these relationships when you’re in trouble. That’s when banks will get very discriminating and not know who you are. But if you have had a line of credit for three or four years and then get in trouble, they’re typically there for you, because you already have built a business relationship, and they see your current situation as more of a blip.”

There’s also a hidden benefit to building that banking relationship: It broadens your focus from today’s financial challenges to planning for future growth.

Here are some ideas from the March issue of Inc. magazine about where to find competitively priced loans:

1. Ask your accountant and lawyer for referrals. They’re tuned into the most sophisticated borrowing practices among local small businesses.
2. Consider Small Business Administration (SBA) loans. SBA Express, a new SBA program, allows businesses to borrow up to $150,000 without going through the standard SBA application process. Rates are competitive, the process is easy, and a loan decision is guaranteed within 36 hours. Call your local SBA district office or visit the agency’s Web site, www.sba.gov. (Click on “financing”). For links with other lending sources, click on “outside resources.”
3. Check rates with major finance companies. Examples are General Electric Capital Corp. (“GE Capital”) and the business credit division of Sears, often more competitive than banks or vendors.
4. Check with a local community bank. Contact the Independent Bankers Association of America, which can provide leads to more than 5,000 community banks, at (800) 422-8439 or www.ibaa.org.
5. Use online credit search engines. Inc. recommends those that guarantee confidentiality, don’t charge an up-front fee, and can point to successful results in linking companies similar to yours with legitimate lenders. Try www.getsmart.com. It’s affiliated with 17 banking and non-banking lenders. The site was launched last year and draws about 1,700 loan applications from small businesses each month.
6. Consider asset-backed borrowing as an option only if you can’t get credit elsewhere. This can be as simple as a home-equity line of credit or a transaction tied to accounts receivable, contracts, or inventory. GE Capital publishes a “Guide to Asset Based Lending.” Call (800) 572-1838. Inc. considers this a valuable source of information but advises readers to skip the company’s six-page sales pitch. One caveat: Joe Romano of Scull and Co. cautions that asset-based lending should be a last resort for funding because jewelers risk losing control of the business if they’re unable to repay the loan.

All of the JCK poll respondents who borrowed money in the last year used funding from commercial banks. This table shows additional sources of funding used.

“It’s difficult to convince people to remember how bad it got when gold and silver prices and interest rates took offsimultaneously.” — Mark Hogeboom, James Avery Craftsman

“Jewelers used to know their banker personally. Now you have to build a financial relationship in writing.” — Mark Hogeboom