There are few words and ideas that strike fear into entrepreneurs and small business owners, especially Millennial entrepreneurs, more than debt. Scarred by the financial crisis, and often juggling student loan and other debt burdens, debt is correctly viewed as something that can upend or even sink a business.
Interest payments by themselves, not to mention principal repayments, can eat up cash flow, prevent entrepreneurs and businesses from expanding, and limit opportunities for future growth.
Although the concept of debt most often has a negative connotation, it is important to recognize that debt is just another tool in the toolbox that entrepreneurs have access to. Obtaining financing is a necessary part of any business, especially for an enterprise seeking to bootstrap itself off the ground.
That said, getting over the apprehension of debt and debt issues, and the legitimate fear or making an incorrect decision with your business finances can be easier said than done.
As a CPA I can attest that there are certainly situations where taking a loan, obtaining a line of credit, or accessing other forms of debt can help you and your business grow. Before anything else, remember that you are in control of your finances — debt is a tool for you to use, and can help your business grow when used correctly.
Let’s take a look at some these specific situations and facts to keep in mind:
1. For developing a new product or service.
No matter how fantastic your newest innovation may be, and regardless what type of business you’re running, you need capital to bootstrap your ideas. While you may have confidence in your ideas, the reality is you may have to produce a proof of concept before investors will believe.
After a thorough analysis of the financial pros and cons, taking on debt to help your launch or finish your new ideas can be an excellent use of this tool.
2. When you want to keep control.
Every business, after cutting through all of the jargon and buzzwords, has two sources of capital available to them. You can raise capital in return for ownership interests in an organization, and this capital is yours to keep for as long as you desire.
Debt, although it has interest associated with it, doesn’t require you to give up ownership of your business. This benefit of raising debt is not often discussed, but is something that should be taken into consideration when you are thinking of obtaining external financing.
3. Taking advantage of the tax code.
This may be more or less relevant for your business, but the fact is that business interest payments are tax deductible, as opposed to payments made to equity investors. Put another way, the benefits of this tax deduction can be summarized as follows.
Assuming you and your competitor operate equivalently profitable businesses, the business that has financed itself with debt with generate higher profitability figures than the business that used equity investors.
4. When it’s cheaper than other sources of funding.
You and I can both read the agreements that are signed when you or your business borrow money — loan duration, interest rates, and any applicable fees are explicitly spelled out. This can reinforce the notion that borrowing money is always more expensive than attracting equity investors.
Drilling in deeper, however, it is apparent that equity investors require control, possibly a share of the profits, and maybe a return on their investment through an eventual sale of the business. Taking a step back to see the big picture can save you money in the long run.
Debt, both for individuals and for small businesses, is a critically important topic that can make the difference between success and failure for your business. Although this topic, and the implications of making a mistake with debt, can strike fear into the heart of entrepreneurs, remember that you are in control of your financial future. Taking a step back, objectively analyzing the situation, and using debt when necessary can help your business grow, expand, and continue providing value to the marketplace.