Ways to Use Debt As a Small Business Owner

Small business owners are the backbone of the American economy. However, carrying such a great load means carrying a great deal of debt. In fact, according to the 2021 Small Business Credit Survey, 79% of small businesses have outstanding debt. Unlike many personal debts, business debts are often necessary. As a business owner, you’ve probably experienced the need to take on and use debt in your business.

Each day you go to work, you make decisions that can impact the lives of many but being frugal and making wise decisions goes well beyond your own personal debt. Your family, your team, and their families depend on you. That’s why you must ensure that you have all the tools you need to conquer and leverage your business debt when necessary.

Oftentimes, you’ll hear the talking heads on television and radio offering debt-reduction tips. As a business owner myself, I often get frustrated with their recommendations, though. They spout out impersonal and nonspecific ideas. It’s rare to hear them speak directly to business owners. I’d like to change that. So, let’s explore some of the types of debt you could encounter in your business.

Business Lines of Credit (B-LOC)

A Business Line of Credit (B-LOC) is a very common debt among business owners. Revolving in nature, you can borrow money and pay it back over and over again. Typically, I recommend most business owners have a Business Line of Credit. But why?

Let’s say you’ve?just completed a major client project, but you haven’t received payment yet. In a perfect world, you’d have enough cash in the bank to cover your expenses. But, as you know, we live in an imperfect world. So, in this scenario, you’ve just made a massive purchase to help grow your business strategically.?

Because of this purchase, you are running tight on cash. Unfortunately, your payroll is due and with cash on the low end in your business account, there just isn’t enough in the bank to cover it. This is where a Business Line of Credit could help. You simply borrow enough money from B-LOC to cover your payroll, and then, pay it back after you’ve received payment from your customer.

To be clear, you should only use a line of credit for short-term expenses. The idea is to use the line and pay it off quickly. Eventually, you should get to the point where you’ve built up the cash reserves in a way where you seldom use your line of credit.

Real Estate Loans

Real Estate Loans are another common business debt. Sometimes it becomes necessary to purchase a piece of real estate or make improvements to your business’s current location.?Just as you would when buying a house, you may need to take out?a loan to purchase property for your business. Whether you need land to build on, or you’re a tenant and the building needs improvements, real estate loans are an important tool for business owners.

When dealing with business real estate loans, it is often best to keep your down payment as low as possible and finance your terms for as long as possible. This will enable you to leverage your cash. Instead of tying up all your cash in a short-term loan, you could deploy your cash throughout your business strategically.

For example, let’s say your business is growing at a rate of 10% per year. Meanwhile, your real estate loan is financed at 5%. In this case, you could use your excess cash to grow your net worth faster by putting it back into your business. Think about it. Does it really make sense to use cash that could yield a 10% return in your business to reduce a 5% debt? In many cases, real estate loans should be on the lower end of your business’s payoff schedule. Although being debt-free is wonderful, you can often use your business’s cash flow in more advantageous ways than eliminating real estate loan debt.

Equipment Loans

This is a debt that I rarely condone. I have the philosophy that no debt is good debt when it comes to equipment loans. Far too often, business owners borrow money for equipment they deem necessary when, in reality, they got lured into buying the latest and greatest from a slick salesperson. Don’t get me wrong. There are certainly instances where an equipment purchase is necessary. But, in many cases, the equipment you already own could continue helping you grow your business.

The key to determining if it’s a smart decision to use an equipment loan is life expectancy. It simply makes no sense to rapidly pay off a piece of equipment with a life expectancy of 10 years. This is especially true if you’re putting a strain on your cash flow to do it. On the other hand, you don’t want to use a 10-year note to finance a computer with a 3-year life expectancy.?

Basically, you want to rank the payoff schedule of your equipment loans in relation to the equipment’s life expectancy. If you do not know the life expectancy of your equipment, you can turn to the IRS for a depreciation schedule for most types of equipment. If the schedule allows the equipment to be depreciated within 10 years, then your loan term should not exceed this standard. Remember, the key to this type of debt is to match the equipment loan term to its life. Then work to pay off the equipment before it becomes obsolete.

Business Purchase Debt

There are a few very good reasons to use Business Purchase Debt. Maybe you need to acquire another company to help your business grow. When making that purchase could double or triple the size of your company, it makes sense from a strategic standpoint.?

Perhaps you’re an entrepreneurial doctor just finishing your residency and you’re ready to dive headfirst into business ownership. You could save until you have enough to purchase a medical practice, but that could take you decades to accomplish. There aren’t many who want to go out on their own after 10-15 years of practice. More than likely you want to do it early and for many reasons. This means using a loan to purchase an existing practice could be necessary.

Leveraging Business Debt

Business debt, unlike most personal debt, can be used strategically to increase your business’s value. Changing locations could change the dynamics of your company, bringing an influx of business. Perhaps you’ve identified a few tactics that will increase your bottom line, but you lack the cash flow to implement them. In cases like these, a loan could be your best option. When used properly, business debt could serve as an income-producing debt. On the other hand, personal debt is often used for consumption purposes.?

Whether you’re buried in business debt or just starting out and need funding, you must have a plan to pay down your debt. Nobody wants debt hanging over their heads or holding them back from reaching their full potential. So, what are the best and most efficient ways to knock out your business debt?

1. Create a Budget!

If you don’t already have a business budget , shame on you. That could be part of the reason you’re in so much debt. Just like your personal budget, a business budget can help keep you on track and actually free up money to pay off your debts.

2. Cut Unnecessary Expenses.

If you look hard enough, you’ll find wasteful spending in even the most efficient businesses. Therefore, it should be no surprise that your business could be wasting money in areas you aren’t paying attention to. This is especially true if you don’t have a budget. By eliminating wasteful spending, you can free up cash to allocate toward your debts.

If you’re using your business debt in a productive manner, then you should be able to create a plan to increase your revenue. Additional income means you’ll have more money to pay down your debts.

Talk with your lenders about the terms and interest rates available to you. You could benefit from a lower interest rate on a business credit card, or you might get more agreeable terms by refinancing a loan. Whatever your needs may be, communicating with your debtors can help a variety of situations. Most companies would rather work out a plan than to not receive payment because your business couldn’t survive the financial burden. Other options for reducing your business debts may not be ones you really want to consider.

4. Cut Charitable Giving.

If you’re a charitable person like I am, you enjoy sharing your wealth with others. However, if your business is experiencing lean times, you may need to cut back on your charitable giving to pay down your debt. It’s better to stop giving for a short time while you recover than to continue giving until you have to close your doors. At that point, you’ll be forced to stop giving anyway. Once you’re back on track, you can always go back to giving.

5. Consolidate Your Debt.

Debt consolidation is a last-ditch effort. If you’re able to lower your interest rates or shave years from your debt repayment schedule, then it could be beneficial for helping you reach your business goals.

Here’s the thing with business debt—it’s not always bad. It can even be necessary, at times. Of course, the goal is to pay it off or keep it to a minimum. However, debt in your business has the potential to become a money-making investment when it’s used properly. Different from personal debt, business debt is seldom used for consumptive purposes.

For example, I’ve seen many young entrepreneurs borrow money to start their businesses. I’ve seen these start-ups quickly gain traction, creating new jobs, and dramatically impacting their communities. In these cases, debt was merely a tool to help them accomplish their mission. Therefore, there are times when debt can be advantageous. Here are a few ways to ensure the debts you use in your business meet those criteria.

• Don’t Sell Your Equity.

First, think twice before taking on a partner if you didn’t start out with one. It doesn’t matter how well your business is performing. Inevitably, there will be lean times. When you find yourself amid these times, don’t sell your equity by adding partners to capitalize your business. It’s more advantageous to take on debt, in this case. Why?

Well, it’s a lot easier to pay off a loan than to get rid of a business partner. Getting rid of a partner can turn into a nasty legal mess that you just don’t need!

• The ROI is Greater Than the Debt.

Another instance where debt could benefit your company is when the return on investment (ROI) will bring in a greater profit than the cost of the debt.

Here’s an example. I have helped business owners borrow funds to make strategic purchases involving other businesses. In the cases I’ve personally helped with, these businesses complemented their current structure. As such, I’ve seen their purchases yield three to five times greater returns than trying to fund an increase in business out of cash flow alone.

• You Need to Purchase Inventory.

In some instances, using debt to purchase inventory can save you money in the long run. For example, let’s say you own a seasonal business and need the capital to purchase inventory for the upcoming year. So, you take out a loan to cover your inventory and now you’re ready to go for your seasonal rush. But there’s an additional benefit that could come from this.?

By pre-purchasing your inventory, you could yield higher profits since you bought your inventory out of season and, possibly, at a time when it was at its lowest price. The point is this — debt is not evil. Debt is neutral. It’s about how you use debt that matters.

How Business Debt Affects Your Credit

As we come to our conclusion, it’s important to understand how business debt can affect your personal credit. Although your business finances are often separate from your personal finances, the two can easily intertwine in the credit world. How’s that possible?

As an entrepreneur, you have likely relied on, or are currently relying on, your personal credit score to establish some of your business credit. This is common, in the early years. However, you don’t want to keep it this way.

Setting up the proper business structure can help you avoid this. When operating your company as an LLC, S-Corp, or C-Corp, your business will have its own credit score, called a PAYDEX? score. The PAYDEX? score is issued by Dun & Bradstreet and rates how quickly your business pays its bills, provides a delinquency predictor score, a financial stress score, a credit limit recommendation, and a risk rating.?

But that’s not the only credit rating your business could have. Experian and Equifax also report credit ratings for small businesses. These reports are commonly referred to as your Business FICO score.

Additionally, when it comes to credit, you cannot control when your business debt will affect your personal credit score. This is especially true when you’re operating as a sole proprietor. This makes sense because, if you are a sole proprietor, you are the business. Whatever you do personally, reflects on your business, and vice versa.

Personal guarantees are something else to be aware of. If you personally guarantee a business loan and your company defaults, your creditors can come after you. It doesn’t matter how your business is structured. By giving a personal guarantee, you’ve said that you would bear the responsibility of repayment.

Understanding business debt and how to utilize it is imperative to running and growing a successful business. So, if you have debt, that’s not necessarily a bad thing.

However, you must realize that there are pros and cons to having those debts. One pro could be profiting from a better location for your company, while a con could be missing out on valuable tax planning advantages because of your debts.

As with all actions you take in your business, you should strategically plan your business debt. If you need to eliminate some of your debt, personal or business, to take your business to the next level, begin the work of aggressively paying down your debt. Otherwise, use it to your advantage. As always, consult your advisory team before making any major decisions.