Business debt may make good sense
Published in The Tennessean October 6, 2014
By Ed Rappuhn – SCORE Nashville
“Our 3 year-old business is doing well. We have never had a loan and I believe in being debt free. My partner is pushing to get a loan to help us grow. What do you think?”
Starting a business without debt is a great idea. It’s difficult for start-ups to get loans and it allows you to prove your concept without worrying about payback schedules.
You have shown financial discipline by surviving and even growing without debt. Now look at your future goals and what it will take to get there. Are you happy where you are or do you want to do more but are limited by available cash?
Running a business debt-free is admirable, but sometimes not preferable. To grow a business, you need to invest in the business. To this point you have invested hard work, your profits, and perhaps some of your own money. To grow further, borrowing might be necessary. Let’s look at some examples.
Advanced Marketing has the opportunity to land a $125,000 annual contract. Advanced has produced a sample ad campaign using in-house talent and cell phone video. The client loves the concept. To proceed Advanced will need to hire outside production for $30,000 to produce the final product but only has $10,000 cash.
HC Technologies has developed a product that is in great demand in the health care industry. Because of its technical nature, on-site visits are needed to close sales. The current sales person closes 25% of his prospects. Hiring more sales people could increase sales several times current levels. Having invested so much on product development, HC is short on cash.
Billy’s Cabinets is growing fast. Clients pay within 30 days of installation. But invoices for materials and employees’ wages must be paid first. Billy’s needs some cash to fund receivables. The faster the growth, the greater the need.
Apex Spices manually packages special recipe mixes. Apex is growing and hiring more people to package the product. A machine that will do the work of 3 people who are paid $18,000 each can be bought for $28,000 but profits have been spent on marketing.
Judy’s Cookies has been leasing kitchen facilities and Judy has the opportunity to buy her own store including baking equipment. She can increase production and sales but needs additional cash to get the building.
Look at the cost of borrowing, financially and psychologically. If the expected benefits outweigh the cost, it is time to rethink your no-debt policies. Alternatives include term-loans with level payments over certain time periods and lines of credit where you only pay interest as money is needed. Few large businesses run without debt; they realize that a loan at 7% that generates a 20% return is good business. The same might be true for you.
Ed Rappuhn is a mentor, workshop facilitator, and the past-chair of SCORE Nashville. SCORE mentors guide entrepreneurs in starting and growing their businesses. Sign up for a free SCORE mentor, find out about our reasonably priced workshops and other services, or volunteer to become a SCORE member at www.scorenashville.org.