The Double-Edged Sword of Business Debt

Many businesses live in fear of debt, particularly after the 2008 financial crash and the climate of fiscal austerity that followed. It’s certainly a bad idea for individuals and households to go heavily into debt, but borrowing is a vital tool for a growing business. So when is business debt advantageous, and how can you manage it most effectively?

Sometimes it’s between business debt or equity.

If you wish to raise substantial funds, there’s a clear alternative to business debt, but it’s not a very attractive one. Instead of borrowing to power business growth, you can approach investors and sell them an equity stake. You will not have to account for any repayments, or pay any interest, but at the same time will dilute your stake in the company – which could prove hugely expensive if it becomes a runaway success. Further, you will have another stakeholder in the firm, who may have a different view of its future and may expect to be consulted on all your future plans.

Funding growth through your cash flow can be slow and unpredictable.

Another way to fund growth without getting into business debt is via your cashflow. In simple terms, this means reinvesting any surplus cash after you have paid your staff and your bills. It’s an extremely reliable way of financing expansion, and once again avoids borrowing, but unless your cashflow is exceptionally positive can prove unreliable and frustratingly slow.

How business debt can make the difference:

However ambitious you are and however visionary your business plan, it can be virtually impossible to achieve swift, sustainable growth without a significant amount of cash on hand. By choosing to take on business debt, you can ensure you have the money you need to buy new equipment, hire new employees, move to new premises or serve new customers, who will require delivery of your product or service before they pay you.

In particular, business debt can be very advantageous for businesses operating in markets with significant economies of scale. If you have the cash on hand to buy in bulk, you can cut your unit cost and make your prices more competitive – or alternatively increase your profit margin.

Finally, there are times when a borrowing facility is literally a lifesaver. A few late-paying clients can seriously damage your cashflow, and without being able to take on temporary business debt you may find yourself insolvent and potentially out of business.

When business debt can be damaging:

However, business debt can be dangerous too, and excessive borrowing has seen many businesses go to the wall. This can especially be the case for businesses that are growing fast – there’s a huge temptation to over-commit and take risks in order to fund new premises, plant and people, and if speculation doesn’t pay off or new customers don’t pay quickly the result can be disaster.

It’s also important to think long-term, as business debt could entail a financial commitment lasting a number of years. We are currently enjoying an unprecedented period of very low interest rates, but these could rise over the next few years, significantly impacting the finances of businesses whose borrowings are subject to a variable rate.

You can also expect all borrowing to be expensive if your business represents a high risk. This can easily occur through no fault of your own, as some sectors are traditionally riskier than others, but if your firm has a poor credit history you are virtually guaranteed high rates of interest. It is also possible that you will be required to provide a personal guarantee for the loan, meaning that if the business defaults you become personally liable for the business debt – up to and including your home.

Finally, even if you can afford to repay your loans, business debt can impact your cash flow for years to come. In other words, ensuring you have the cash you need now can prevent you from having cash on hand when you need it in the future.

So should you borrow or not?

There’s no easy answer to this question: it depends entirely on your circumstances at the time. Business debt can be essential to drive your business forward without losing equity, but if you overreach yourself it can have serious consequences in the future. Ultimately, to achieve success you should be bold without being foolhardy – and only you can decide where to draw that line.

As Managing Director of Cashsolv, Carl Faulds offers advice and support to overcome cash flow problems and identify possible underlying problems that can be addressed to ensure a positive future for your business. Carl continues an ethos of working with distressed businesses to help them overcome their financial problems.