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Small Business Debt: Friend or Foe?

Novice business owners tend to shudder at the thought of debt – after all, even a little debt means monthly payment obligations, and too much will sink the company. But small business debt, while perhaps scary when viewed in a vacuum, is a very normal and often necessary part of the growth cycle.

Once in a while, a small business is able to get off the ground thanks to a grant, and a few entrepreneurs even fund startup costs themselves. But usually, a small business at some point will need to take out a loan for the big influx of capital to either get things started, to expand or launch its next big product.

Small business debt is far from your worst enemy, then. You just need to know when to use it, how to use it, and how it can turn from friend into foe.

When to Use It: The most obvious thing to consider when you’re taking out a loan is whether you’re addressing a want, or a need. For instance, if you need new equipment to fulfill projects, or if you need to launch a marketing/advertising campaign to bring in business, those are perfectly acceptable reasons to take on debt. A state-of-the-art game room to boost employee morale is not.

In some cases, you may have no choice but to pay on debt. Even successful businesses need to lease or take out a loan or afford big-ticket purchases such as real estate or buildings, as well as making acquisitions of other companies.

It also makes sense to use it when other options aren’t as attractive. For instance, some companies might choose to sell an equity stake in their company to raise necessary capital. But you don’t repay a partner like you do with debt, they share in your profits instead, plus you give up some amount of control as well. Once you pay off a debtor, they’re gone.

How to Use It: Not all loans are the same, and you can be strategic with small business debt.

If you know you’re going to be selling tangible goods soon, consider buying those goods with short-term credit that you can repay soon after selling them. For example, a baseball cap company that knows it’ll be selling hats outside a sporting event may consider financing production, then repaying the debt with the proceeds immediately thereafter.

But short-term financing can be more expensive, so make sure to only use it for short-term purchases. If you put a large purchase that’ll take many years to finance on, say, a credit card, you’ll end up paying much more in higher interest rates. Instead, if you’re doing something big – such as a renovation – bank loans, which have lower rates, are the way to go.

How Debt Can Turn From Friend to Foe: If you’re in a place where you won’t be able to pay back the debt you’re taking out … avoid it if at all possible. If you already have a high level of liabilities compared to your assets, or aren’t very profitable when compared to your assets, chances are debt will become a chain around your neck. Borrowing with a low credit score – and thus enduring high interest rates as a result – is another path to ruin.

In short, if you’re in a position to improve your financial situation before taking on debt, that’s typically the best option.

What is your financial situation? Talk to the consultants at McManamon & Co. to determine whether taking on small business debt is the right thing to do, and if you’re in a position to do so.

Debt doesn’t have to be a financial boogeyman. Call us at 440.892.9088 or contact us online to learn more about what loans, leasing and other financing options can do for your small business.

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