The word “debt” has a negative connotation for some small business owners since it conjures images of credit card bills and unpaid invoices. However, debt isn’t necessarily a bad thing. As a business owner, you may even take on debt to fund the expansion and growth of your businesses by applying for a small business loan, line of credit or other type of financing.
As a business owner, debt isn’t necessarily a bad thing — you may even take on debt to fund the expansion and growth of your businesses.
When you take on debt in a strategic, planned fashion, you are taking steps to set yourself up for success in the future. Here are four good reasons to take on business debt.
The money you spend on your business doesn’t just disappear into the void. If it does, you may need to rethink your spending. Each charge to your business lowers the amount of cash you have while increasing your assets. This is the basic principle of double-entry bookkeeping.
For example, if you spend $25,000 on a new delivery van, then you will have $25,000 less in cash but that amount in equipment assets. While your assets will depreciate over time (that van won’t drive forever), it will provide concrete value to your business and enable you to grow your sales to accommodate customers that want deliveries.
The risk of taking on small business debt through external funding can often be justified because that debt directly feeds the goal of growing the value of your business. The debt you take on enables you to increase your sales in ways you couldn’t before. Once you pay off that debt, you can focus on your profits.
While many business owners immediately understand how investments in real estate, equipment, and materials can result in good debt, some have a harder time understanding marketing investments. It’s much harder to understand how paying a marketing agency is growing your assets, even in a bookkeeping ledger.
Marketing agencies, contractors, and employees provide value to your business in multiple ways. They create physical assets like your website and social media profiles, which drive traffic and customers to your stores. They also create campaigns that promote your brand and products, increasing your sales and brand equity.
You can take out good debt to invest in marketing as long as you have a target ROI (return on investment) to work toward. For example, if you bring in $500 in sales for every $50 you spend on digital ads, you have a 10:1 ROI. You can also track the gross margin of the items you sell to ensure you are turning a profit from your marketing efforts.
Marketing can help you grow your sales, which will drive up your revenues and help you pay down your debt faster.
Every organization has a business credit score, also called a commercial credit score. Like a personal credit score, this rating determines how reliable your business is to lend to. If you are a young business or have outstanding debts, you might have a small business credit score. This could make it harder to secure loans or credit cards while driving up the interest rates you are given.
While you can’t fix your business credit score overnight, there are ways to improve it over time. You can pay off your outstanding debts and pay back loans within a set window of time. This proves to lenders that you care about your finances and can reliably follow a payment schedule.
If you have multiple sources of debt, consider working to consolidate them. You may be able to take out a loan to pay off these debts, leaving you with just one monthly payment. Meet with an accountant or financial advisor first to see if this would be an effective way to improve your credit score and set your business up for success.
Improving your credit score now will make acquiring debt cheaper over time. You can enjoy lower interest rates and more favorable payback periods.
There are multiple ways to fund your business beyond taking on debt. For example, you can invite investors to buy into your business and bring on shareholders who will earn a portion of your profits. These options have become more popular recently thanks to the mind-boggling venture capital funding in search of startup unicorns.
However, working with investors and shareholders doesn’t mean you get free money. These people often want to be involved in your business decisions. You will need to explain to investors exactly how you plan to spend their money and what returns they can expect. You will also need to list your shareholders on your business taxes.
In some cases, it may be better to take on debt for your business without inviting individuals to buy into it. You can do whatever you want with a business loan as long as you pay it back in set installments. A business credit card gives you the flexibility to spend money without gaining approval first.
Plus, taking on debt might be cheaper than bringing in venture capital. You can deduct any interest you pay on your taxes and may find more favorable interest rates in SBA (Small Business Association) loans over private investments.
Debt isn’t something you need to avoid. There are times when your business will take on debt to expand or retain more long-term control. As long as you have a plan to use the money and a set period to pay it back, then you don’t have to be afraid to take it on.
If you are considering taking on some external financing, ask your accountant to look at your balance sheets and identify a reasonable debt-to-income ratio. This process will review the amount of debt you can afford to take on based on a set monthly payment and give you the peace of mind to ensure you aren’t overwhelmed in debt while trying to cover your monthly business expenses.