Debt ignores your results
A lender's payment doesn't shrink because business was slow, an investor eats bad months with you.
Volume 03, Chapter 5
Loans and Debt Financing
Equity shares your results. Debt ignores them. Can this business pay a fixed amount every single month, even in its worst month?
The Golden Rule
A loan is the mirror image of equity. You keep 100% of the pizza, but the payment arrives every month like rent, in good months and terrible ones.
If yes, debt is usually cheaper than equity. If no, a loan can kill a business that equity would have saved. Test it against your worst recent month, never your best.
Flat or reducing?The same "20%" can differ by hundreds of thousands of naira.
Test the worst monthPayment no more than a third of your worst month's profit, not your average.
Collateral is realNamed assets, often the business's own machines, are at risk.
Flat vs reducing balance
One "20%" quote costs ₦2,000,000; the identical-sounding other costs ₦1,110,000.
Two slow months = default
Miss the payment twice and the collateral, often the business itself, is at risk.
Write down even the friendliest loan
Unwritten family loans turn into arguments about whether it was ever a loan at all.
1
Definition
Imagine Mr A takes ₦5,000,000 from Mr B two different ways. In the first version, Mr B becomes a part-owner: if MANIAC MINDZ has a slow month, Mr B earns less too. In the second version, Mr B is a lender: MANIAC MINDZ must pay him a fixed amount every single month, whether that month was excellent or terrible. Same ₦5,000,000. Two completely different risks for Mr A to carry.
The second version is a loan, rented money. The lender hands over a sum (the principal), the business pays a fee for using it (interest), and returns it on an agreed timetable (the repayment schedule). No ownership changes hands, but the payments are owed whether or not the business is doing well.
In One Sentence
A loan is the mirror image of equity. Equity: no repayment promise, but you give away a slice of everything forever. Loan: you keep 100% of the pizza, but the payment arrives every month like rent, in good months and terrible ones. The whole decision comes down to one question: can this business pay a fixed amount every single month, even in its worst month? If yes, debt is usually cheaper than equity. If no, a loan can kill a business that equity would have saved.
2
The Rented Shop Explanation
You already understand loans, because you understand rent.
When you rent a shop, the landlord doesn't own your business, but the rent is due on the 1st whether you sold a hundred garments or none. The shop must eventually be handed back in good condition.
A loan is renting money instead of a room:
Principal
The amount borrowed.
The shop itselfInterest
The fee for using the money.
Monthly rentRepayment Schedule
How much, how often, for how long.
The lease termCollateral
An asset the lender can take if you default.
Your depositDefault
Breaking the terms, seizure or lawsuit follows.
Eviction| Renting a shop | Renting money (a loan) |
|---|---|
| The shop itself | The principal (the sum borrowed) |
| Monthly rent | Interest (the fee for using the money) |
| The lease term | The repayment schedule |
| Your caution deposit | Collateral (an asset the lender can take, see Chapter 6) |
| Being evicted for unpaid rent | Default (breaking the loan terms, the lender can seize collateral or sue) |
| The landlord's opinion of your sales | Irrelevant. Rent is rent. |
Memory Trick
Equity shares your results. Debt ignores them. An investor eats bad months with you; a lender's payment doesn't shrink because business was slow.
3
The Five Words on Every Loan Document
| Term | Plain Meaning | In the Example Below |
|---|---|---|
| Principal | The amount borrowed | ₦5,000,000 |
| Interest | The price of using it, usually % per year | 20% per year |
| Repayment schedule | How much, how often, for how long | Monthly, over 24 months |
| Collateral | The asset pledged if you can't pay (secured), or none (unsecured) | The industrial sewing machines |
| Default | Failing the terms, triggering seizure of collateral, penalties, court | Missing payments |
4
The Worked Example: The Loan Mr A Almost Took
Remember the case study: Mr A's first instinct was to treat Mr B's ₦5,000,000 as a loan, "I'll pay you back over two years with interest." Here is the math he ran before changing his mind.
The offer: ₦5,000,000 at "20% per year," repaid monthly over 24 months.
Step 1: Ask which kind of 20%: flat or reducing balance?
This one question changes the total by nearly a million naira:
| Flat rate | Reducing balance | |
|---|---|---|
| How interest is counted | On the full ₦5,000,000, every year, even as you repay | Only on what you still owe each month |
| Interest over 2 years | 20% × ₦5,000,000 × 2 = ₦2,000,000 | ≈ ₦1,110,000 |
| Total repaid | ₦7,000,000 | ≈ ₦6,110,000 |
| Monthly payment | ₦7,000,000 ÷ 24 ≈ ₦291,700 | ≈ ₦254,500 |
Same words, "twenty percent", two very different prices.
Warning
Small-business lenders frequently quote flat rates because they sound equal but cost more. Before signing anything, ask: "Is this flat or reducing balance? What is the total amount I will have repaid by the end?" If the lender won't answer the second question in one number, walk away.
Step 2: The affordability test (this is where the loan died)
MANIAC MINDZ's profit is about ₦4,000,000 per year ≈ ₦333,000 per month (the valuation math behind this is Chapter 11).
| Amount | |
|---|---|
| Average monthly profit | ₦333,000 |
| Flat-rate monthly payment | ₦291,700 |
| Left over, in an average month | ₦41,300 |
| Left over, in a slow month (profit ₦200,000) | −₦91,700 |
The payment would eat up 88% of an average month's profit, and in any slow month, the business couldn't pay at all. Two slow months in a row and MANIAC MINDZ is in default, with its sewing machines (the collateral, the business itself!) at risk.
That's why Mr A chose equity: Mr B's dividends shrink in bad months; a bank's payment never does. The right funding wasn't about which is cheaper, it was about which one the worst month can survive.
Sticky Note Tip
A working rule of thumb: total loan payments should stay under one-third of your worst recent month's profit, not your average, and never your best. Test the loan against the month you'd rather forget.
5
Loan vs Equity, The Classic Comparison
| Loan | Equity | |
|---|---|---|
| Ownership given up | None | A permanent slice |
| Must be repaid? | Yes, principal + interest, on schedule | No repayment promise (Chapter 6) |
| Payments in a bad month | Unchanged, due in full | Dividends simply shrink or pause |
| Say in decisions | None (though loan conditions can restrict you) | Depends on share class (Chapter 4) |
| Cost if business grows 10× | Fixed: just the interest | Huge: the slice grows 10× too |
| Cost if business struggles | Dangerous: payments continue regardless | Shared: investor loses alongside you |
| If business fails | Lender is a creditor, paid before owners | Investor paid last, often ₦0 |
| Ends when? | Final payment, then it's over, cleanly | Usually never, unless bought back (Chapter 14) |
| Best when | Cash flow is steady and predictable | Cash flow is uneven, or the money funds a risky leap |
The deep pattern: debt is cheap when things go well and cruel when they don't; equity is expensive when things go well and merciful when they don't. You are choosing which future you'd rather pay in.
6
Advantages and Disadvantages of Borrowing
| Advantages | Disadvantages |
|---|---|
| You keep 100% ownership and control | Payments due regardless of performance |
| Fixed, knowable total cost | Interest can be brutal at small-business rates |
| Ends cleanly at the last payment | Collateral puts named assets, often the business's own machines, at risk |
| Repaying on time builds a credit record for bigger, cheaper loans later | Personal guarantees can cancel your limited liability protection (Chapter 6, Section 6) |
| No new voices in decisions | Loan conditions may restrict borrowing, big purchases, or dividends until repaid |
7
Common Mistakes
Common Mistake #1: Testing the Loan Against Your Best Month
Affordability decided in optimism, paid in reality. Use the worst recent month (Section 4, Step 2).
Common Mistake #2: Not Asking "Flat or Reducing?"
The single most expensive unasked question in small-business finance, Section 4, Step 1.
Common Mistake #3: A Short-Term Loan for a Long-Term Purchase
Funding a machine that pays for itself over five years with a loan due in twelve months guarantees a cash shortage. Match the loan's length to the life of what it buys.
Common Mistake #4: Signing the Personal Guarantee "Formality"
That signature quietly converts a company loan into your debt. Read Chapter 6 first.
Common Mistake #5: An Unwritten Loan From Family
Family loans with nothing in writing change over time: was it a loan? A gift? An investment, "so really I own part of this now"? Write even the friendliest loan down, the template below takes ten minutes.
8
Template: Loan Agreement
Every loan, especially between friends and family, deserves to be written down: Loan Agreement Template. It captures the five words of Section 3, the flat/reducing question, and what happens if payments stop.
9
Quiz Yourself
Quiz 1
Name the five core loan terms.
Principal, interest, repayment schedule, collateral, default.
Quiz 2
₦2,000,000 borrowed at 15% flat for 2 years. Total interest, total repaid, and monthly payment?
Interest = 15% × ₦2,000,000 × 2 = ₦600,000. Total = ₦2,600,000. Monthly = ₦2,600,000 ÷ 24 ≈ ₦108,300.
Quiz 3
Why did the same "20%" cost ₦2,000,000 one way and ₦1,110,000 the other?
Flat rate charges 20% on the full principal every year; reducing balance charges only on what's still owed, which falls every month.
Quiz 4
A business with wildly seasonal sales asks whether to fund expansion by loan or equity. What's the first question, and the likely answer?
"Can the worst month cover a fixed payment?" With seasonal swings, often no, pointing toward equity or revenue-based structures (Chapter 7) instead of fixed debt.
Quiz 5
True or False: taking a loan gives the lender a say in how you run the business.
False in ownership terms, no votes, no equity. But partially true in practice: loan agreements can impose conditions (no new debt, no large asset sales) until repayment.
10
Practice Exercise
Run the two tests on a real or imagined loan for your business:
- Get (or invent) an offer: principal, quoted rate, term. Ask/decide: flat or reducing?
- Compute total to repay and monthly payment both ways (Section 4's tables show the method).
- Write down your worst month's profit from the last year. Divide payment by it. Over one-third? The loan fails the test.
- List what you'd pledge as collateral, then reread that list slowly. That is what default costs.
- If the loan fails, don't stop: Chapter 7 holds the structures built for exactly this situation.
11
Quick Summary
Quick Summary
- A loan = rented money: principal + interest on a schedule, owed regardless of results.
- The five words: principal, interest, repayment schedule, collateral, default.
- Always ask flat or reducing balance, the same "20%" differs by hundreds of thousands of naira.
- The only affordability test that matters: can the worst month pay it? (Aim: payment no more than a third of worst-month profit.)
- Debt is cheap in good futures, cruel in bad ones; equity is the reverse, that's the real choice.
- Write down every loan, even family ones: Loan Agreement Template.
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