7 Reasons Why Debt is Good for Your Business
Debt is often perceived negatively. Debt can be “evil”, “crippling” and an “unforgiving master”( the last one from the Google query “Debt is…”;). It can suggest a lack of sufficient cash flow and an inability to fulfil your funding requirements. It also an indication of increased risk, as if you are unable to service your debt repayments, it could have dire consequences for your business.
There is however a good side to debt supported by the fact that the majority of the most successful businesses have some level of debt. It can be a great way for individuals and businesses to earn a return on their investment. And of course it is an integral part of the engine that drives the world economy.
For small business owners, debt can significantly improve your bottom line as long as it is managed responsibly.
Check out my related newsletter article on Good Debt vs Bad Debt
1. Debt can help you grow your business
One of the primary ways to grow your business is to take on debt. Many small business owners find themselves at a crossroads when facing rapid growth as they are not able to finance their expansion on their own. When this happens, access to debt in the form of lines of credit, bank loans ond other third party debt allows small businesses to expand.
2. Debt is cheaper than equity
A fundamental concept in finance, when discussing the cost of capital, is that debt can be cheaper than equity (investing your own money).
One the primary reasons for being in business is to earn a higher rate of return than you would get from putting it in another type of investment. This means that as a business owner you expect a return on equity that is higher than the cost of debt.
More debt allows you to have a lower equity base resulting in a higher after tax profit/equity return rate. This is especially meaningful when you are calculating earnings per share.
3. Government sponsored debt programs
Both Canada and the U.S. offer government-backed loan programs designed to help small businesses get access to financing at competitive rates. These programs have favourable repayment terms, and in some cases, loans may be partially forgiven if the business is unsuccessful. These programs can make borrowing less risky and more attainable for new or growing businesses.
For a list of funding programs offered in Canada check out this link
4. Mitigates your risk
It is rarely a good idea to put all of your proverbial eggs in one basket. Using business debt allows you to share risk with lenders and limit your personal exposure if things don’t go as planned. And while bankruptcy is never ideal, having borrowed funds rather than investing all of your own assets can reduce the long-term financial impact.
5. Suggests confidence in your business:
If someone is willing to lend your business money (other than perhaps some generous family members) it suggests that they believe that your business has potential.
The loan application process often requires business plans, projections, and a thorough understanding of your operations all of which reinforce your professionalism and credibility.
6. Helps you build credibility and maintain discipline
In the same way that credit cards help you build a credit profile, debt helps you build relationships with financial institutions and other debt holders. Others are more likely to lend to your business when they see that it isn’t the first time.
If you continue to make your payments on schedule, it is much easier to expand your credit facilities.
Finally since most debt agreements have reporting and financial covenants, it helps you to maintain financial discipline for your business.
7. Interest is tax deductible:
The cost of debt is actually less on an after tax basis than the interest rate suggests. If your interest rate is 5% and your business tax rate is 20% then the effective cost (interest) of your debt is actually only 4% which is a significant tax savings.
It goes without saying that there should be careful evaluation of your business circumstances prior to taking on debt. There are many businesses, often service based, that have low capital requirements and do not require much in the way of additional funding. And of course debt should not be used to replace fiscal discipline.
