Is There Good Debt for Your Small Business?
When you hear the word debt, you may cringe because it is a reminder of an obligation and payment that you have to make until you have cleared what you owe. However, your relationship with debt doesn't have to involve dread. Instead, you can think about how debt has its place in your small business in certain situations. Here's where debt can be a good thing for your business:
Funds your startup
I am one of many entrepreneurs out there who bootstrapped their business and used savings and some debt to launch my first business. I wasn't entering a business where I felt I needed a ton of capital so a bank loan and venture capital was out.
Instead, I used small loans and credit cards to provide additional funds to help with some of my startup expenses. In doing so, I ensured I could get as much as possible for as little money or debt. In this way, I covered the cost of equipment and some basic operating costs until I started making some money. This made my savings go farther as well.
Improves business credit score
If you have a low credit score from never using any credit prior, debt can be good if you take some out and repay it before the due date. Continuing to make small purchases on credit can then establish and improve your business credit score. This strategy will help you take our more credit in the future should you need to make a larger purchase.
Helps you expand
Like your initial development, debt can also be good when it helps you get to the next level of business growth. Again, this is a point where you don't necessarily need a large sum of money. While you might be able to attract investor attention, it is better to continue bootstrapping your business to manage the company's financial position.
A line of credit or credit cards can help to purchase additional equipment, bring in more talent, expand your manufacturing relationships and even cover physical space for that expansion. The expansion will bring in additional revenue that can then help you get that debt paid back quickly.
Manages seasonal changes
Even though you plan appropriately for slow periods due to having a seasonal business, it still may be necessary to leverage a small amount of debt to see you through and prepare for the next round of sales.
This is a good use of debt because it is temporary and can be paid back during the upcoming seasonal rush. In this way, you can purchase enough materials, hire staff, and undertake additional marketing to even stimulate seasonal sales at an earlier date.
Conserves cash flow
If you know you are making something that will sell within weeks, then it makes sense to buy some supplies or materials on credit. This is smarter than using up available cash flow. You can then maintain that cash for anything unexpected that happens prior to selling those products or if you experience an economic downturn.
Saves you from selling off equity
When you need cash flow, some entrepreneurs decide to sell their equity to others. However, you have just given up some control over your own business, including its direction and future, by handing a piece of it over.
Instead, you could consider a short-term loan or line of credit where you can get some cash while maintaining control. It's on you to pay back the principal and interest but at least you don't have to contend with one or more people who want to change your company.
Words of warning
Everything comes with a certain amount of risk because there is no guarantee of success in business. Although each of these examples of good debt represents a smart strategy, the external environment could change at any time and leave you without the additional revenue you had hoped would come from tapping into debt. There is still a risk that your business will fail and you will be left with the obligation of repaying the principal and interest on that debt.
Therefore, you want to always make sure you take or use as little debt as possible rather than having debt for debt's sake. Establish a repayment plan and alternatives prior to taking on any type of debt to keep you on the repayment track so you can make the most of the benefits that some debt offers.
Also, make sure you clearly understand the terms and interest rate involved in taking this debt on so that you do not miss payment deadlines and create a larger problem for yourself and business. Consider shopping around before getting a loan or business credit card so you get the best rates for the money you are borrowing.
With this strategy in place, you should be able to leverage the benefits that debt can bring for your business, including start-up capital, expansion, talent, materials, inventory, equipment and more. Every one of these strategies is about developing your business, taking the approach that sometimes you do have to spend (or borrow) money to make money.
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