When is it the right time to take out a business loan?
No one likes the prospect of being in debt. Owing money can sometimes be a stressful situation, but having access to funding is an important part of business growth, and borrowing can sometimes be the only way to take your business forward.
Debt can carry a stigma for some people but, if managed well, debt can also be the leverage you need to lift your business to the next level. History is full of examples of wealth created through the careful use of other people’s money.
In today’s low interest rate environment, it is the perfect time to borrow money at a low rate and use it to help your business make handsome profits.
The first question for many business owners looking for additional capital is should they take on debt or consider equity – adding new shareholders? There are several pros and cons to each.
Advantages of taking on debt
Debt offers the benefit of maintaining control and ultimately the greater share of profit should the business be successful. Interest rates on debt seldom reach the level of return that a good investment can provide – the cost of single digit interest rates can be minimal in comparison to a double-digit yield on a successful investment.
Debt can also offer the benefit of tax deductibility. If structured correctly, the interest costs of debt can be deducted from pre-tax income, helping to reduce your tax bill. Profits are always paid out after tax, so having an equity partner who you must share profits with won’t offer this benefit.
The other advantage of debt over equity is the ability to maintain control. Once the loan is approved, the lender can’t really tell you how to run your business. As long as payments are made, they generally won’t interfere. Bringing in equity partners can be about more than just the money. Many won’t want to have a passive role, and you may find yourself having to appease your new investors. Decision making may no longer belong exclusively to you.
Advantages of taking on equity
Equity investors can have their benefits also. Higher risk investments may see many lenders reluctant to lend funds, while an investor who is willing to take on a higher risk for a higher return can be a benefit. This can be advantageous for start-ups or businesses undertaking a new path in a competitive environment. With an equity investor, there is no obligation to make them regular payments or return their capital. They are also committed long term, which prevents the need to revisit the lender for refinancing when the loan period ends.
An equity investor can also bring expertise to the table. They may have previous experience in this area and having them as part of your management team or board of directors can be even more beneficial than the capital they contribute.
You need to consider several factors when deciding between debt or equity but ultimately the biggest consideration may be risk versus return.
If you believe your investment offers a good return and a high probability of success then debt will allow you to maximise your profits.
Riskier or start up scenarios may see equity as the preferred choice.
Ultimately it will come down to the choices you can consider in both areas. Reluctance by lenders or an absence of equity options may see the decision being made for you.
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Article content courtesy of Bigstone Capital.