At some point, your small business will need more money. You’ll need more space, inventory, or equipment and there won’t be enough money in your business bank account.
When you get to this point, you need to take on debt. Don’t think of business debt as bad. Learning how to get your business out of debt isn’t always the best option for growth. Getting a business loan can be a good thing that improves your business.
Reasons to take on business debt
Is your business a good candidate for taking out a small business loan? In general, if the loan will improve your bottom line in business, take it. Check out the following reasons to take out a loan to see if business debt is a good choice for you.
You want to expand
Your business might eventually get to a point where you need more money to continue growing. You might need more inventory or new products to sell. You might need new equipment to provide more services and attract bigger clients. Or, perhaps you need a larger retail space to fit more customers or host events.
Without money, you can’t buy things that will make you more money. When you don’t have enough in your business savings account, a loan can give you a financial boost. If all goes well, your investment will make enough to pay off the loan and start earning your business more than before.
You want to build your credit score
To get a loan, you need good credit. And to get good credit, you need experience taking out and paying off loans. This cycle can be frustrating for some small business owners.
You can improve your small business credit score by taking out small loans. You can show your lender that you are capable of handling a loan and its repayments. By building your credit score with smaller loans, you make it easier for your business to get approved for bigger loans later.
Taking on smaller amounts of debt now also helps you build a relationship with your lender. A good relationship with a lender might help you get approved for larger loans. And, you might receive other benefits, such as reduced interest rates.
You want to hire an employee
If you’re spending as much time as you can on your business and more still needs to be done, you might benefit from hiring an employee. But hiring an employee can be an expensive investment, especially if you don’t have much extra cash.
You can take on business debt to hire an employee. The debt might be worth it if the employee helps you earn more money. For example, you hire a salesperson. The salesperson generates more income for your business, which pays off the loan and increases your profit.
Or, you can hire an employee to free up your time for profit-generating tasks. Let’s say you hire an assistant who takes over many basic yet time-consuming tasks. You now have more time for improving and marketing your business.
Reasons not to take on business debt
While business debt can be beneficial, it’s not good for all businesses.
“Debt requires repayment with interest,” say Doug and Polly White in an Entrepreneur article. “In general, if the debt isn’t repaid in a timely manner, the debt-holders can force the company into bankruptcy. That is, they can force the company to liquidate its assets to repay the debt (or, at least, as much of the debt as the company has assets to cover).”
Before taking out a business loan, make sure you’re capable of business debt management. Here are two reasons you shouldn’t take on business debt.
You don’t have a good ROI
Before you take on small business debt, you should measure your return on investment (ROI) to make sure the debt is worthwhile. ROI measures how much you get out of your investment. Your ROI should outweigh the debt.
Let’s say you take out a $10,000 loan to buy new inventory. You have to pay back an additional $3,000 in interest. You sell the inventory for $60,000. You end with a profit of $47,000. ($60,000 – $10,000 – $3,000). In this case, you have an ROI of $47,000, which makes it worth it to take out the loan.
When calculating your ROI, don’t be too optimistic. While you are hopeful about your business, there’s a chance your venture won’t go as well as you hoped. It’s better to think conservatively and figure a lower ROI to determine if taking on business debt is a good idea.
You can’t pay it back
If you don’t think you’ll be able to pay the loan back, don’t take on debt to begin with. Seriously consider how successful you think you’ll be.
If you take on debt and can’t pay it back, you’ll hurt your business. Your business credit score will drop. Lenders will distrust you. You might go into business bankruptcy and lose your whole business. You can avoid all of this by only taking on debt you know you can pay back.