Business debt is tempting. What could you do with a whole, or at least a little bit, more cash in your business?
This is the allure of debt. It’s about the possibilities that open up when you have additional spending power in your business. Quite simply more cash flow opens up possibilities.
The reason debt can be such a game changer for SMEs and startups is that one of the biggest bottlenecks for their growth is cash flow. So taking on some debt has the potential to make a huge impact in your business’s future.
But as we all know, with great power comes great responsibility. And with great amounts of debt come great amounts of interest. But unlike our radioactive spider-bitten friend who didn’t know what he was getting into, when it comes to debt, there’s plenty of information out there for you to make an informed decision.
In this article, we’ll go over the pros and cons of the different forms of debt and how you can leverage them to help grow your business.
Before you go out looking for business debt
The first step before going out looking for funding is to have a solid plan and budget in place to know how you’ll spend every dollar that is loaned to you. There are many ways to approach this, but working out some scenarios is a good idea.
If you’ve already done that and have your accounting in order, here are a few more questions you need to ask yourself when evaluating what type of debt you’ll bring on.
- How much will you end up paying? This is a simple question that can sometimes be hard to answer. Luckily there are plenty of calculators and spreadsheets available that can help you crunch the numbers.
- Will you make more profit with the extra cash? The answer to this question should be without a doubt positive. However, if you aren’t sure of how much profit you’ll be able to extract from the acquired loan, you probably need to take a look at your business plan.
- How quickly will you be able to pay it off? Paying a loan off as quickly as possible will typically save you money. So having an ambitious debt payment plan can help you save money. If you don’t have a solid budget, taking on debt isn’t the best idea.
- What could prevent you from not being able to pay off the debt? This isn’t about being pessimistic, rather about being aware of what the worst-case scenario for your business looks like so you can avoid it.
Business Credit Cards
Business credit cards are a great option if you are looking for a short term loan. Also, they’re significantly better than using your personal credit cards, which you should avoid.
Pros:
- Points, rewards, cashback promotions and other benefits
- They typically have lower APRs than consumer cards
- They help keep your expense management organized
Cons:
- Banks can have strict qualification guidelines which can make them hard to qualify for
- Some may have annual fees and require great credit scores
Personal loans for business use
If you are just starting out or don’t have enough operating history, applying for a personal loan for your business can be an option. This is the route that many business owners follow to get their startup off the ground.
Pros:
- They can be approved quickly
- A great option for new businesses
Cons:
- They depend entirely on your personal credit
- If you fail to pay or have any delays it will impact your credit score
- Depending on your credit history, you may only get small amounts
Term Loans
A term loan is probably what you think of when thinking about a loan. You get a lump sum and pay it in a predetermined amount of time at a given APR. These are one of the easiest options to access for small businesses that have been established for some time, since time in business is one of the main eligibility criteria.
Pros:
- There’s a large marketplace for term loans
- You can get low APRs
- Many term loans have the option to pay early so you can save money
Cons:
- Usually not an option for startups and new businesses
- You may need collateral
- Your credit score may impact your eligibility and APR you are offered
SBA Loans
Small business administration loans are loans that are specifically aimed for small businesses through SBA agencies. You can think of them as a regular loan but with terms that are more favorable for small businesses since they are backed by the SBA.
Pros:
- They offer better terms and payment options than what typical term loans offer
- The funds can be used for multiple businesses purposes
- If you qualify for one, lenders try to make it easy to apply
Cons:
- You need to have been in business for at least 2 years. Thus, new businesses and startups aren’t eligible
- The process to apply for them can be complicated and it can take months in some cases
Business lines of credit
A business line of credit is a flexible loan for businesses where you can use whatever you need from your approved line of credit. You can think of it as a credit card of sorts.
Pros:
- You only pay interest on what you borrow
- Lenders typically offer larger amounts than what is available with credit cards
- You have quick access to your credit line which makes it great for meeting short term cash needs
Cons:
- The process for getting a line of credit can be very meticulous
- Lenders will require a healthy track record of your financials as well as collateral in some cases
- Not an option for new businesses or startups
Convertible Notes
Convertible notes are a fairly common financing strategy for startups. The “notes” are loaned funds and instead of those loans being repaid, they typically convert into preferred stock in the company itself. Instead of interest, the investor is rewarded with shares.
Pros:
- Convertible notes are simple in nature and quick to set up
- Notes are often given in the first round of funding, before evaluation
- Often attractive for potential investors, meaning more interested parties
- More control for the Founder/Owner of the company and limited “repayment” pressure
Cons:
- Some investors preferred solid repayment terms and interest rates
- Potentially giving up stake in your business early on
Invoice Factoring
Invoice factoring loans are loans that lenders give against an unpaid invoice on your products/services. Your business sells an invoice to a lender so you can get the money that’s owed to you minus a commission and fees.
Pros:
- It’s a great option to get cash quickly. Invoice factoring companies typically have fast approval times
- Typically available to businesses that can’t get other type of financing
- Great option if you have a long invoicing cycle
Cons:
- Fees can be high. They range between 1% to 5% plus additional transactions fees. Also, in some cases you may not get the complete sum of your invoice
- Some invoice factoring companies will collect directly from your customer
- The approval may depend on the creditworthiness and payment history of your customer
How to think about business debt
Onboarding debt can be a great tool to help spur business growth, invest in equipment or weather a cash crunch so you can get out of a rough spot. There are plenty of financing options, some better than others. So it’s always a good idea to know what is available to you beforehand so you can choose the financial product that fits your needs the best.
With careful planning and good budgeting, you’ll be able to leverage these financial products to help take your business where you want it to be.