One of the scariest parts of managing your business’ finances is debt.[cite::219::cite] In fact, it seems that adults are just as afraid of debt as kids are of the dark! But, this fear may just be fear of the unknown. Let’s shine some light on this subject, so you can see how debt is actually a good, healthy part of your business.
The reason debt is so terrifying is because of what it may tell an investor about your business. It could indicate that your business is lacking funds or can’t repay what it owes, which investors will take note of when deciding what kind of risk they are taking by investing in your business. But, there is also a flip side to what debt can do for you. Here are four reasons why debt is actually good for your business.
1. Debt can grow your business
By taking on debt, you are acquiring money now that you will have to pay back later. Your business benefits from this because you have the funds to maintain your business’ growth and momentum without the delay of finding investors. So, even though this money does have interest associated with it, the ROI is much greater because odds are your business’ growth will outweigh your interest rate. Additionally, you can get the exact funds you need in one place through one loan, rather than having to find multiple investors who are hopefully willing to invest enough for your business to obtain equipment, space or manpower to grow.
2. Debt is easier and cheaper to obtain than equity
To segue from reason No. 1, equity is harder to obtain than debt because normally there is no legal obligation to repay investors. In fact, investors are the first to lose their investment when a business goes bankrupt. So, they are more cautious to provide capital than a financial institution is to give out a loan. That being said, it also actually costs more to obtain equity, i.e. an investor, because an investor will look for a higher rate of return than the interest rate that is attached to a business loan. Seeing as the investor stands to lose much more than the financial institution if the business should go south, this makes sense. Investors generally look to get a 10% ROI when investing in a business.
3. The government supports businesses having debt
The government provides different loan options for small businesses that allow owners to borrow money at competitive interest rates. This makes sense because a new, successful business boosts the economy and creates jobs. Additionally, with these types of loans, the debt could potentially be largely reduced or forgiven should the business fail. So, win-win.
4. Tax incentives
Can I get a tax break?! Yes, actually you can! The government allows a tax deduction on the interest that a business owner pays on debt from corporate income. This is a very nice incentive seeing that the corporate income tax is one of the highest in the world. That being said, after the tax break business owners generally see an interest rate that is under 5%, which is fairly low for the cost of borrowing money.
Debt doesn’t sound so bad now does it?! In fact, you may be thinking, “why don’t I just finance everything?”
First, having investors means more than securing financing. Investors often offer a wealth of knowledge and a considerable amount of connections for your business to utilize. Let’s face it, investors want to see you succeed because they would like their ROI.
Second, because having your business built on “all debt” would be too risky to those financing you. Financial institutions don’t want to see your business have to pay off debt with more debt. For example, paying a car payment with a credit card. The car payment will be paid, but you are still in debt for that amount because it wasn’t actually paid, the money just moved from one creditor to another. And, of course, unmanaged debt can lead to some pretty serious consequences for your business.
As a responsible business owner, you should: have a sound business plan, know the projections for your business’ financial future, understand your business’ capabilities, and have a strategy for debt repayment. The best way to ensure your business is on the path to financial success is to consult your investors and your business’ financial planner and/or banker. Remember, there is nothing to be afraid of once you turn on the lights and see the debt monster for what it is: a manageable and essential risk.