Small Business Debt – Can It Really Be A Good Thing?
Generally speaking, ‘debt’ is considered to be a dirty word. Company owners who have business debt can be perceived by the uninitiated to be bad managers of money, who aren’t good at forward-planning, are not able to function within their means and are trying to prop up a failing enterprise by borrowing.
Well, that may all be so of course but, looking at the issue from a different angle, taking on debt can also be seen as an investment in the future of the business. Debt is very like alcohol – it certainly can be an evil, but it all depends on how responsibly you handle it.
Here are some common questions asked regarding the ins and outs of business debt and some of the ways it can work to your best advantage.
‘What’s the difference between beneficial business debt and bad business debt?’
A business entering into beneficial debt is basically employing a method of injecting cash or assets to promote growth or to enable profitable contracts to be fulfilled. Usually it’s when the company either doesn’t have the funds itself or doesn’t want to commit large amounts of its own capital at that point. The balance between the cost of the debt and the profits it will enable has to be carefully calculated and, of course, there may be an element of risk.
Bad business debt is probably more obvious to quantify. Businesses which overstretch themselves, try to grow too quickly and rely on massive borrowing for long-term day-to-day survival may be creating problems which can’t be resolved. Once the situation has been reached where loans are defaulted on because there isn’t enough income to service them, then the business is in real trouble.
‘I need a cash injection for my business to grow. How can I achieve that, and do I have to go into debt to do it?’
There are several traditional ways to inject cash into a business, some of which have more difficulties and pitfalls than others.
For bigger companies, flotation on the stock market and selling shares in the business is one way to go. It doesn’t involve going into debt, but has inherent problems of having to pay shareholder dividends, being accountable to those shareholders for the way the business runs, and dealing with the market fluctuations which are beyond your control, to name but a few. There is a good article here about the pros and cons of floating your company.
For business owners who don’t have stock market ambitions there are several traditional, but possibly less than ideal, options:
- Selling equity in the business, either directly to a partner or by obtaining venture capital from an investor, is a way to achieve a cash injection without taking on debt. The downside is that you will land yourself with one or more partners who will not only profit from all the hard work you’ve already put in, but may want to take the business along future paths you don’t like. You worked hard to get your company where it is – do you really want to hand over part-control to someone else?
- Bank loans and overdrafts are the traditional way to raise capital. They are often at better interest rates than other forms of borrowing but do have their drawbacks. Loans can take a long time to be approved and, if your need or project is time-sensitive, this may be too long to be a viable option. An overdraft can be arranged much more quickly but has the disadvantage of being easily recalled by the bank, which could cause a very difficult financial situation.
- Credit cards can be useful if used in the right way. They’re a quick and easy method of obtaining funding when you want it. Short-term borrowing on a card can be an effective method of buying a small quantity of stock for a specific event, for instance. You need to do the calculations beforehand to make sure that the ROI is going to be enough to pay back the amount borrowed as quickly as possible, avoiding paying a lot of interest.
‘I’ve invested heavily in assets for my business and I own them outright. I now need working capital for an expansion or a big project. Is there a way to unlock some of that invested cash?’
Actually yes, there’s a very neat way to make those purchased assets work even harder for you than they do every day. Asset refinance is a method of raising working capital on plant, machinery or vehicles for example, which are owned by the company.
Basically, you provide information on the asset – its make and model, how old it is, when you bought it (with proof of purchase) and how much use it has had (e.g. miles driven, or hours run). The funder will assess that information, make a determination of how much the asset is worth today and will offer to lend an amount of money accordingly, with the asset as collateral. An agreement will be drawn up and you will commit to repaying the loan over an agreed number of months at a set rate of interest. These agreements can usually be arranged in a very short time.
There are benefits on both sides. For you:
- You will get your working capital without having to sell any assets
- You won’t have to wait possibly months for a decision
- You know exactly how much you’re paying back each week, month or quarter and for how long, making it easy to budget and manage your cashflow
- The business can continue using the asset as usual through the loan period
- Payments count as profit/loss items, so will appear on the balance sheet
- If you stick to the terms of the contract, the funder can’t call in their loan before the end of the term, unlike an overdraft
For the funder:
- The load is secured on the asset, so if you hit a problem and can’t honour the contract, the funder can liquidate the asset to recoup their money.
‘Are there any alternatives to either using capital, taking a loan or asset refinancing for acquiring business assets?’
Yes. You could consider asset finance to source the assets that your business needs. An amazing range of assets can be subject to finance arrangements, including machinery, transport and IT equipment. It works in a similar way to the asset refinancing described earlier in that the lease term and monthly repayments will be agreed at the beginning – but basically for new assets rather than those you already have. Again, this provides you with the tools you need without spending valuable capital and makes budgeting easy. Check out some of the finance options here.
Yet another alternative is invoice financing. This handy option means you don’t have to wait for customers to pay the invoices you send out. Instead, you pass them on to a funder who will advance a pre-determined percentage of the value of the invoice, usually up to 90%, and at a fixed rate. This gives you cash with no waiting, enabling your cashflow to keep flowing and your business to carry on growing. There’s more information on invoice financing here.
As you see, there are many and varied ways to obtain working capital for the next step of your business journey. Not all of them involve taking on debt but, hopefully, this article has shown that carefully-managed business debt isn’t the black beast it can be perceived as. Stop thinking of debt as a negative thing and start regarding it as an investment tool that can help you achieve your aims. All you have to remember is to carefully calculate how you’re going to cover repayments and make sure you stick to the letter of the agreement. If you have any doubts that you can – don’t do it!
If you need some help in deciding whether asset finance, asset refinancing or invoice financing might work for your business, have a chat with us at Anglo Scottish Finance. We have dedicated and very experienced teams dealing with all these options and will be happy to discuss ways to help you achieve your business goals.