Taking on debt can be an intimidating move for a small business or entrepreneur — it can feel like a risk. It might feel safer to use savings or a more familiar method of funding like business credit cards. But there can be huge benefits to using debt for business growth. Debt can offer opportunities for business owners that would have otherwise been out of reach.
In this article, we’ll explore the ways that good debt can help your business grow, why it’s essential to manage debt responsibly, and how to find the right type of business financing for you.
What Are the Benefits of a Company Taking on Debt?
Taking on debt to grow your business can be unnerving if it’s new to you. But debt can give you exactly the boost you need to grow your operations to the next level — and beyond.
Here are the main positives of using debt for business growth:
- Gives you access to more funding than internal savings or credit would offer.
- Can use the funds to help grow customer base, sales, locations, and ultimately increase profitability.
- On-time payments can help build business credit history, which helps open up new financing opportunities.
- Interest payments are often tax deductible.
- Business owners maintain full ownership, unlike equity financing.
What Are the Disadvantages of Debt?
Now let’s take a look at the potential downsides of relying on debt to grow your business:
- Must pay back the funds with interest.
- Taking on too much debt can lead to high monthly payments.
- Must be carefully managed to avoid overleveraging debt and causing financial strain on your day-to-day operations.
How Does Debt Help a Company?
Debt isn’t inherently bad — it’s all in how you manage it. In fact, small business loans can be helpful for a business in several ways. We’ll explore these different ways that debt can help a business maintain and grow their business:
- Capital expansion: Enable growth by using debt to add new inventory, explore a new project, open a new location, and more.
- Build credit history: Making monthly payments can help build business credit history and unlock new financing options. Better credit may help secure low interest rates.
- Deduct interest payments: Payments made on business interest can usually be deducted from business taxes to lower tax liability.
- Maintain ownership: Unlike taking on investors, using debt allows small business owners to keep control of their company’s decision making.
What Are the Benefits of Debt for a Company?
Let’s explore the ways taking on debt can help businesses thrive in more detail.
First, having debt can be used for capital expansion. Taking on debt can provide an influx of cash for a company to expand its operations, invest in new projects, or acquire assets. This allows your business to take advantage of growth opportunities that might otherwise be inaccessible.
Having a responsible level of debt can actually enhance a company’s credibility and creditworthiness in the eyes of lenders and investors. It can signal that the company is capable of managing its finances and has a plan for repayment. Plus, debt payments that you make may be reported to business credit bureaus to help you build credit history.
Learn all about how to establish business credit and boost your business credit score in this Nav guide. Better personal credit and business credit can help you to qualify for lower interest rates.
Interest paid on business debt is generally tax-deductible, which can reduce your business’s overall tax liability. This tax shield can make debt financing more cost-effective than equity financing in certain situations.
When a company raises funds through debt instead of equity financing, it doesn’t dilute the ownership of existing shareholders. Equity financing means you give up some control of your company to the investor, but debt financing doesn’t involve giving up a portion of ownership in the company.
However, it’s important to note that while debt can be beneficial, it also comes with risks. Excessive debt can strain a company’s cash flow. Make sure you can afford to pay back any debt you borrow.
What Is the Difference Between Debt and Equity?
Debt and equity are two distinct methods of financing a company:
- Debt: Debt financing involves borrowing money that the company agrees to repay over time with interest. This can take the form of loans from banks or alternative lenders, or issuing bonds to investors. Debt represents a liability on the company’s balance sheet and typically involves fixed interest payments. It doesn’t dilute ownership of the business, meaning the company retains full control of decision making. However, it comes with an obligation to repay the borrowed funds.
- Equity: Equity financing involves selling ownership stakes in the company to investors. This is typically done by issuing shares of stock or bringing an investor on board. Equity doesn’t require repayment like debt, but it means giving up a portion of ownership. Equity investors become shareholders and have a claim on the company’s assets and profits. They can benefit from capital appreciation and may receive dividends, but they also bear the risk of potential losses if the company’s value decreases.
The choice between debt and equity depends on various factors, including your business’s financial strategy, capital needs, risk tolerance, and preferences. Each method has its pros and cons, and companies often use a combination of both to achieve their financial objectives.
Why Is Debt Good for Growth?
Business debt allows you to pay for expansions, invest in new opportunities, and take on larger-scale projects that would otherwise be out of reach using savings or other internal funds. Debt can serve as a leveraging tool to allow for more rapid growth and expansion.
Moreover, by using debt strategically, companies can take advantage of tax benefits associated with interest payments, as well as improve their overall financial flexibility. More flexibility can enable you to navigate challenging economic conditions while continuing to increase your customer base and sales.
However, it’s important to manage debt levels carefully. Additionally, consider how much you’re able to repay to avoid taking on too much and creating potential financial instability.
How Does a Company Raise Capital Through Debt?
A company borrows money from external sources, like banks, financial institutions, or by issuing bonds to investors, to raise capital through debt. This process typically involves the company agreeing to repay the borrowed amount over a specified period with interest.
The specific steps to allow you to use debt financing involve:
- Evaluating how much you need. It’s best to know exactly what you’ll use the debt for before you borrow. Don’t take out more debt than you need.
- Determining the type of debt. The different types of financing include short-term or long-term loans, lines of credit, merchant cash advances, working capital loans, and more.
- Finalizing the terms. The terms depend on the type of loan and include interest rates and repayment terms. Make sure you understand them fully before you sign.
Then a business applies for the funds from lenders. Using Nav is the easiest way to find the right small business loan options tailored to your business.
Your business may offer collateral on bank loans, like real estate or other assets, to secure the debt, which can lower the cost of borrowing. Once the debt is issued, you can use the funds to invest in operations, get new equipment, or meet other financial obligations, while making periodic interest and principal repayments according to the terms of the debt agreement.
How Can Being In Debt Affect Your Ability To Have a Successful Business?
It’s important to note that being in debt can impact your ability to succeed if it’s not managed correctly. While debt can provide essential capital for growth, excessive or mismanaged debt can burden your business with high interest payments and repayment obligations, potentially leading to financial distress and even bankruptcy.
Too much debt can strain cash flow, making it difficult to cover operating expenses or respond to unexpected challenges. High debt levels can also erode profitability, creditworthiness, and overall financial stability, which can deter investors, lenders, and customers. Therefore, managing debt levels carefully and balancing them with the company’s financial health and potential returns is crucial for ensuring that debt supports rather than hinders business success.
How Does Debt Affect a Company’s Profitability?
Debt can have both positive and negative effects on a company’s profitability, and a lot of its impact depends on how much you borrow and how you manage it. Profitability is (in basic terms) the amount of money that’s left over after you calculate income minus expenses.
The risk to profitability boils down to this: Debt doesn’t technically contribute to your income, and it requires you to pay it back, with interest. While taking on debt can offer quick access to needed funds for investments and expansion, these regular payments can eat into your company’s profits.
Good management of debt levels and a careful balance between borrowing and financial stability are essential for maintaining a healthy and sustainable level of profitability.
Additionally, high levels of debt can increase the financial risk and interest rate payments, potentially leading to financial distress if the business can’t meet its debt obligations. This can result in a decrease in investor confidence, even higher borrowing costs, and limited access to additional funding.
On the other hand, having a reasonable amount of debt can improve a company’s return on equity by using borrowed funds to generate higher returns — and increasing profitability.
How Does Debt Relate to Growth?
Debt is closely intertwined with a company’s growth since it can provide the necessary financial resources to pay for expansions, research and development, and other growth initiatives that would otherwise be out of reach with savings or income alone.
By utilizing debt, companies can take advantage of opportunities that would have remained beyond their reach using only their existing resources. Small business owners first need to clearly understand the rate of return they expect on any project they’re planning to take on debt for.
This additional capital can fuel investments in things like new projects, acquisitions, and new technology, which ultimately fosters business expansion and enhances overall growth prospects.
However, excessive debt levels can pose a risk, potentially leading to financial instability and limiting the company’s ability to invest in further growth. It’s critically important to use a balanced approach to manage debt in the context of sustainable growth strategies.
What Are the Benefits of Debt?
Taking on debt can unlock opportunities for small businesses that they would have never been able to reach otherwise. Although it may be automatic to think of debt as something you should try to avoid, it’s worth considering whether it makes sense for your business. Managing business debt responsibly can allow your business to grow in ways you only dreamed of.
If you’re not sure where to start with finding the right business financing, turn to Nav. By adding a few business details to your Nav profile, you can see which business funding options you can qualify for before you apply.
This article was originally written on October 16, 2023.