“But the interest rate is only four percent and that is almost a full point lower than the other guy.”
“It is not four percent and you know it.”
Mateo looked at the paper and he tapped his finger on the bold numbers and he looked at me like I was the one who could not do basic math. He had a deal for a plastic plant in the suburbs of Chicago and the price was $6.4 million and he needed debt to bridge the gap.
He had two letters of intent on his desk and one was from a bank he knew and the other was from a lender he found through a friend of a friend and the second one was the one with the four percent rate. He thought he was being smart and he thought he was saving $64,000 a year in interest and he was already spending that money in his head on a new truck or a boat or maybe just a bigger cushion for the lean months.
I sat there and I watched him grin and I felt a yawn coming on and I did not stop it. It was a big yawn and it happened right while he was explaining his plan to pay down the principal early and it was rude but I was tired of seeing this same movie. I have spent my life looking at lines and queues and the way things flow from one point to another and I know that a bottleneck is never where you think it is and a cost is never just the number on the sticker.
We have a habit of looking for things we can compare and we like rates because they are a single number and we can put them in a list and we can see which one is smaller. It feels like science and it feels like truth but it is a trap. When a lender gives you a rate that is too low for the market they are not doing you a favor out of the goodness of their hearts and they are not losing money just to be your friend. They are making up that margin somewhere else and they are doing it in the parts of the deal that you cannot easily put into a spreadsheet.
The Lesson of the Serpentine Line
I told him about a mistake I made back when I was first starting out in queue management and I thought I was the smartest person in the room. I was working for a large retail chain and they wanted to cut down the wait times at the checkout and I told them we could do it by cutting the staff and forcing the customers into a single serpentine line.
I showed them the math and the math said the throughput would go up and the cost would go down and it looked perfect on my screen. I was so sure of my numbers that I ignored the floor managers when they told me the customers would hate the feeling of being herded like cattle. I yawned during that meeting too and I thought they were just old men who did not understand the beauty of a clean data set.
The lines moved faster but the customers felt trapped and they felt like they were in a prison and they stopped coming back and we lost $2.1 million in sales over just to save $80,000 in labor. I was right about the number but I was wrong about the cost and that is exactly what Mateo was doing with his four percent loan.
The First Hidden Cost: Time
The first hidden cost is time and most people forget that time has a price that grows every day. Mateo was on a clock because his seller was an old man who wanted to retire and the old man had another buyer waiting in the wings.
The cheap lender took just to send the first set of due diligence questions and they asked for things that did not exist and they asked for them twice. Every time Mateo had to stop running his current business to dig up an old tax form from he was losing money and he was losing focus.
The higher rate lender was ready to close in but the cheap lender was dragging their feet and they were doing it because they were understaffed and they were trying to find a reason to raise the rate at the last minute.
Then there are the fees. You have the commitment fee and the exit fee and the legal fee for the lender’s lawyer and the legal fee for the bank’s lawyer and a fee for the guy who walks through the building to make sure the roof is still there.
By the time Mateo added them all up the four percent was starting to look like six percent and he was still telling himself it was a good deal. He was stuck in the sunk cost fallacy and he had already spent ten thousand dollars on a down payment for the appraisal and he did not want to walk away.
The Real Teeth: Covenants and Control
But the real teeth are in the covenants and the control rights. A cheap loan is a leash and the cheaper the loan the shorter the leash. The lender wanted Mateo to keep a certain amount of cash in the bank at all times and they wanted to be able to tell him no if he wanted to hire a new manager or if he wanted to buy a new piece of gear.
They wanted a reporting package every month that would take his accountant two days to build. That is a tax on your life and it is a tax on your brain and it is a tax on your ability to grow.
Structure Over Stickers
If you are a serious buyer and you have a deal that is moving fast you need someone who knows how to look past the first page of the term sheet.
You need a team like Financely because they understand that the structure of the debt is more important than the cost of the debt.
They know that a loan that lets you run your business is worth more than a loan that saves you a few basis points but tries to run the business for you. They work with private credit and global banks to find a fit that actually works for the cash flow of the deal and they do not get distracted by the shiny objects that the cheap lenders use to lure people in.
I told Mateo to look at the section on the second page about the cash sweep and he didn’t even know what it was. It meant that every dollar he made above a certain level had to go straight to the lender to pay down the debt and he could not keep it for himself and he could not use it to fix the roof of the plant.
“He was going to be a servant to the bank for five years and he was going to do it all for a one percent difference in the rate. He looked at the words and he looked at me and he finally stopped smiling.”
A deal is not just a pile of money and it is a living thing that needs room to breathe and if you choke it with bad terms it will die no matter how cheap the money was at the start. The discipline to price the whole structure is what separates the people who own businesses from the people who just own a job that the bank lets them keep.
I learned that lesson the hard way in a retail aisle with a clipboard in my hand and I hope Mateo does not have to learn it while he is trying to figure out why he cannot afford to pay his staff because the bank took his cash.
The cheap lenders use the low rate to get you to stop shopping and they use the delay to get you to a point where you cannot say no because the closing date is tomorrow. It is a predatory kind of math and it works because we are all a little bit greedy and we all want to think we found the one secret deal that no one else saw.
But there are no secrets in credit and there is only the trade between risk and reward and if the reward looks too high for you it is because the risk is hidden in the fine print. You have to be willing to pay for speed and you have to be willing to pay for a lender who stays out of your way. You have to be willing to pay for the right to be the boss of your own company.
Mateo eventually threw the cheap offer in the trash and he went with the lender who actually asked him about his growth plans and he closed the deal in and he is happy now.
He still talks about the boat he didn’t buy but he also talks about the three new machines he bought without asking anyone for permission. He understands now that the price of the money is the smallest part of the deal.
The teeth of a loan grow long when the rate stays short.
We often think that being diligent means finding the lowest number but true diligence is finding the most stable path. It is about the flow of the queue and the steady movement of the capital and the peace of mind that comes from knowing that you are not going to be surprised by a letter in the mail six months from now.
I still yawn in meetings sometimes but usually it is because people are talking about things that do not matter and they are ignoring the giant weight that is about to fall on their heads. I try to point it out but some people have to feel the weight before they believe it is there.
Mateo was lucky because he listened before the ink was dry and he saved himself from a headache that no amount of interest savings could ever cure.