Most businesses will need to borrow money at some point. Some common examples of borrowing needs include start-up funding, capital investment and, more recently, COVID-related operating expenses. Borrowing money should be a careful and well-thought-out decision, and should include a thorough understanding and examination of the terms and conditions involved in the debt contract.
Here are some guidelines on how to borrow money responsibly for your business:
DO Have a Plan on How the Money Will Be Spent
Before you even start looking at options for funding, you should have a current and accurate budget for your borrowing needs. This includes a detailed breakdown of how the money will be spent and how it will be paid back. If you don’t have a clear plan on how to use the money, you can easily overspend and/or spend it on the wrong things. Just like a personal budget, careful planning will go a long way in helping you manage your debt.
DON'T Borrow More Than You Actually Need
Again, a budget will help you decide how much you need to borrow and how to spend your money. It is very tempting to spend excess cash on unnecessary items or take money out of the business, leaving you with less operating capital and less resources to pay back the debt. It will also cost the business more in terms of interest, which hurts the bottom line.
DO Understand the Terms of the Debt Contract
Thoroughly read and understand all debt documents before signing any contract! This includes credit cards and other types of revolving debt. If you don’t understand something, consult an accountant or attorney for advice. For example, SBA loans (yes, those EIDL disaster loans too) come with a host of terms and conditions that can put your personal earnings and assets at risk in the event you are unable to repay the loan. This includes your spouse’s assets and earnings also, even if they are not owners of the business. The SBA has a reputation for being persistent and resourceful in collecting debt (i.e. freezing assets, garnishing wages, etc.), which could haunt you for years to come. If you are not comfortable with the terms and conditions, DO NOT borrow the money. Look for other sources until you find one that will work for you.
DON'T Get Caught in the Revolving Debt Cycle
Although interest-free credit cards and other introductory rates seem like good options, beware the hidden danger of trading one debt for another. “Borrowing from Peter to pay Paul” is an old saying that highlights the risks of getting stuck on the revolving debt wheel, where you never pay off your balances. This cycle results in loads of unnecessary interest and fees, and can easily overwhelm your business if you can’t control the growing debt spiral.
DO Understand Your Numbers
Every business owner should know and understand several key ratios related to their business: current ratio, debt to equity ratio and interest cover ratio. These ratios show how well the business is managing cash and debt, and can be key indicators when the business starts to go off course. I currently provide quarterly reports to my clients that include this information, so we can easily see how the business is trending and discuss how to address issues related to debt management.