Robert Gloer — January 30, 2019 — January 30, 2019
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You might occasionally encounter a business owner who has a dim view of debt. That’s unfortunate, because debt, if you manage it properly, can help you grow your business. Here are several ways your business will benefit from the prudent use of debt:
Accelerate growth:
You can use loan proceeds to buy new equipment/facilities, hire more skilled labor and/or purchase additional inventory. This gives you growing room without drawing down your retained earnings. Naturally, you should have a detailed plan that lays out how you’ll deploy the loan proceeds to achieve the desired results. Failing to plan your finances can leave you in a hole when it comes time to service your debt.
Retain full ownership:
You might want to expand your business and are deciding whether to use debt, equity or a mix of both. Remember that bringing on equity investors gives you new “partners” who’s ideas might be different from yours. By borrowing rather than issuing stock, you remain fully in charge and do not have to share profits.
Tax benefits:
You can deduct you loan interest from your business taxes. As you know, every dollar in business is important, so the tax benefits you receive from borrowing are a significant success factor.
Build your credit:
When you pay your loan back on time (or faster), you likely will increase your credit score and boost your credit limit. This comes in handy as you expand your business, because future loans will be easier to access, and you’ll probably get a lower interest rate and/or higher spending limit. Be sure to check your credit reports and scores so that you can correct mistakes.
Avoid asset sales:
If you find you don’t have sufficient funds to complete your growth plan, you might be tempted to sell off your receivables or inventory. However, asset sales have several problems that reduce their desirability. For instance, your customers might not like being billed by a new entity, and this may cause them to question your viability. Furthermore, the haircut you take on asset sales often exceeds the interest you’ll pay on a loan. Why risk doing permanent damage to your business through asset sales when you can take out a short-term loan instead?
Smooth out seasonality:
Seasonal sales variability shouldn’t stop you from expanding your business. Using debt allows you to smooth out the effects of seasonality and keep your growth plans on track. To that end, make sure you borrow from a lender that doesn’t charge prepayment penalties. This allows you to pay off your loan sooner than anticipated without incurring extra charges.
Financing your ideas:
It takes cash, and often lots of it, to pay for the R&D costs associated with a new product or service. You can obtain cash via debt and plow it into your latest research, both from the operational and marketing viewpoints. Using debt instead of equity helps you maintain your trade secrets when they are most vulnerable – in the development stage. Equity investors might require you to reveal valuable information that can fuel the work of competitors.
Cost of capital:
Debt often has a lower cost of capital than does equity. Equity investors not only require a chunk of the profits, but also might require managerial control, a required rate of return and dividends. Debt is simply priced and avoids some of the costs associated with equity financing.
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