Equity and debt are the two ways to fund your business without taking money from your own pocket. Equity finance means raising money by offering investors part ownership in your business. Debt finance, by contrast, means borrowing money to operate or expand your business. Your company's individual circumstances should determine how much debt it takes on.
Borrowing Money Is an Investment
Money costs money, and the cost of a loan is the debt-service fee - cumulative interest plus any other fees you may need to pay, such as an origination fee. The longer the term of the loan, of course, the more you will pay in interest. If borrowing money will eventually make you more money than you pay in debt-service fees, your "investment" in the loan will be profitable. In this case, borrowing is a good idea as long as you can repay the loan. Nevertheless, there is always the risk that you won't make as much money as you planned to make.
The SBA Access to Credit
Generally, the U.S. Small Business Administration (SBA) guarantees loans rather than loaning money directly. Nevertheless, an SBA guarantee can persuade a reluctant lender to extend a loan because the lender knows that if you don't repay the loan, the SBA will. Whether or not you seek an SBA guarantee, however, your lender will evaluate your application based solely on whether you will be able to repay the loan. It does not consider whether borrowing money is a good idea for your business. Both the SBA and lending banks place restrictions on the use of loan proceeds. SBA loan programs generally guarantee loans for specific purposes, such as purchasing equipment for modernization or acquiring another business.
Using Loans Just to Stay in Business
When a business is just breaking even, it might make more sense to close the business rather than take on heavy debt. This is particularly true if your lender asks you to personally guarantee repayment of the loan. In some cases, however, borrowing money to stay in business makes sense. If your business is seasonal, for example, you might take out a short-term loan for working capital to get you through the slow season. If your business is already in debt, it might make sense to consolidate your loans into a single loan if doing so would reduce your total debt-service fee.
It Takes Money to Make Money
According to the SBA, insufficient investment is one of the main reasons why small businesses fail. Even if your business seems to be staying afloat without relying on loans, you may need to modernize your equipment, acquire an existing business, or build new sales outlets to ensure your ability to compete five years in the future. If your venture succeeds, borrowing money to expand your business can be an extraordinarily profitable investment. However, you must carefully consider your business' actual needs before borrowing money for improvement or expansion. Whereas borrowing money to acquire the latest technology may sound exciting, it may or may not benefit your bottom line.
A Business Lawyer Can Help
The law surrounding the use of loans to finance your business is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a business lawyer.