• Money and finance

The Pros and Cons of Using Debt to Grow Your Business

Guest Blogger | July 5, 2016


Written By: Alex Glassey, www.AlexGlassey.com

49.3% of small business owners said that their business did not have enough money, according to my most recent survey.

In today’s world of inexpensive debt, the solution seems simple enough: Why not borrow it?

Like any powerful tool, business debt is a good news, bad news story. The good news is that properly used debt supports your business and speeds its growth. The bad news is that, used unwisely, debt can constrain or kill your business and even hurt you personally.

Here’s why.

The three things you must know about business debt

Business debt is a product like any other: the bank is simply selling you money. And like any product, it is tailored for specific uses in specific ways:

  1. Business debt is designed for low risk situations. Because of this, banks can provide money inexpensively relative to other kinds of business financing. But this also means that banks will only lend money when they are very sure to get repaid.
  2. Business debt often comes with a “security clause” to help ensure that the bank gets its money back. If the debt isn’t being repaid, the clause gives the bank the right to sell an asset belonging to the business, such as equipment, land or a building.Owners of small businesses with few assets are often asked by the business for a “personal guarantee”. In the event that the business can’t repay the debt, the bank will require the owner to repay it personally. Ouch!
  3. A business is obligated to repay a business debt, regardless of what might happen. This is unlike an equity investment in which the investor agrees to share the business risk with you; if things go well, investors are paid well. If things go poorly, they are paid poorly or not at all.This obligation to repay a debt comes ahead of almost all other normal business payments, including your suppliers and staff. In a crunch, laying off staff becomes “easier” than not paying a business loan.

Slow and steady wins the debt race

The wise business owner knows this and uses debt deliberately and appropriately. She is guided by these three principles:

  1. Don’t “spend” or “gamble” the money you get from a business loan. Invest it in something that you are reasonably certain will generate a positive return. For example, invest in equipment that will more than pay its own way by cutting production costs.Spending it on something like an unproven marketing approach is risky (see point 1 above) and inconsistent with this type of financing.
  2. Ensure your business has predictable cash flow that is more than enough to cover the loan payment. This, in conjunction with the investment philosophy in point A, helps protect the business from unforeseen events like slowing sales or a sharp rise in expenses.
  3. Respect the bank’s right to ask for security, but protect yourself personally. If the bank is asking for a personal guarantee, it may be that they are seeing business risks that you don’t. Discuss this with them thoroughly and find ways to eliminate or minimize their need for your personal guarantee.

Finally, while not directly related to business loans, it’s a great idea to practice sound cash management habits like daily cash reconciliations and monthly financial statement reviews. These disciplines help you understand how a loan will affect your business. They actually make it easier to obtain a loan. And they help you track the on-going health of any loan you do get.

If you treat business loans like I treat my 10” chef’s knife, you’ll do just fine. My knife is a very useful tool and I treat it with a healthy dose of respect.

For more tools around financial planning, visit the Futurpreneur Business Resource Centre