If a worker carries a tool around but never uses it to good effect, it’s merely a burden. Used inexpertly, or for the wrong purpose, it’s also downright dangerous. The same applies to business debt.
On the other hand, when used wisely and well, business debt is possibly the most valuable item in the toolbox.
Although, in some cases, levels of fear and apprehension might rise at the very mention of debt, when business operators take on debt with knowledge and confident planning, what is perceived as risk can be viewed as significant opportunity.
In fact, three out of every four small businesses in Australia report having used external financing to promote growth. And for good reason.
Why use debt?
The greater availability of capital means greater opportunity. It can be the difference between a smart move and a missed chance. In practical terms, it means having the capacity to accept a substantial order, rather than turning away business for lack of immediate funds.
In a competitive market, a business must explore and exploit every opportunity to attract and keep clients. But there are costs involved. How best to meet them?
Initially, the short-term benefits of taking on equity investors bearing cash might seem attractive. But what about the longer term costs, such as the loss of profit share and the relinquishing of at least some control to investors?
Add to that the complex process of finding appropriate investors, and the difficulty in formulating agreements, and debt starts to look like the better option.
In most cases, business can claim a tax deduction related to interest payments on business loans. This swings the balance further in favour of debt, and is another advantage, compared with raising capital through investors.
Debt can, in fact, cost less than the alternative.
It’s also a way to build relationships with lending institutions, some of which provide advisors who will be involved in business growth planning, and be available to offer assistance in future projects.
Debt for growth
There are inherent dangers in taking on debt unwisely. Wisdom lies in strategic planning, and making sure, as far as possible, that business will benefit from borrowed funds.
And the key word is growth.
Borrowing funds to pay staff wages and avoid the struggle of meeting day-to-day expenses may not spell growth. Unless it is a short-term measure, and there are plans or expectations of positive change, this move can spell danger instead. Taking out a loan in order to make cosmetic improvements, based solely on a vague hope business might improve is not wisdom.
When debt is a growth producing strategy, with projected benefits that further the goals a business has articulated, then it is definitely a wise choice.
- An investment in more staff, with better and more versatile skill sets, or in staff training with calculated long-term pay-off. That’s good business.
- The purchase of new facilities and equipment, or spending on improvements and upgrades that have a strong likelihood of producing growth.
- Expansion or improvement of current offerings – to attract new clients, or protect an existing client base from the competition. Remember it’s less expensive to keep loyal clients than to acquire new ones.
- Using debt is also a ‘put your money where your mouth is’ approach that shows confidence. Confidence is contagious. And confident clients are usually loyal clients.
Before taking on debt, businesses need to ask the smart, but really quite simple, questions:
- How will debt help business growth?
- How will debt open up future possibilities?
The bottom line
Think of debt as an investment in the business.
As with any other investment, it’s essential to do a benefit-cost analysis. Calculate benefits, increased revenue, and tax deductions, then subtract expenses, including fees and repayments of principle and interest. In any plans to take on business debt, there are basic steps to take:
- Compare and check interest rates; calculate costs over the entire duration of the loan.
- Consider the timing of repayments; check whether there is flexibility, should circumstances change.
- Check and confirm all applicable fees.
- Find out how long the application process will take, and how soon the funds will be available; a valuable opportunity calls for a quick response.
- Remember too that major lenders are not the only option, especially if a business is in start-up or early growth phase.
After considering all the factors is debt a good investment? How does the ROI look?
When debt is under control, rather than taking control, it’s a smart tool that lets a business ‘get down to business’.