As an attorney with 18 years experience in consumer and business financial debt-related services, Leslie H. Tayne understands the power—and pitfalls—of debt. Her firm, Tayne Law Group, P.C., concentrates on debt management, debt resolution, and bankruptcy alternatives for consumers, small business owners, and professionals who require help managing their finances. Recently, writer Erin O’Donnell spoke with Tayne about the different kinds of business debt and how entrepreneurs can use it wisely to help grow their business.
EO: What kind of debt is good for a small business?
LT: All business debt can be considered good debt until it becomes unmanageable. When growing your business, borrowing from family, business expansion loans, and investor-related loans are all acceptable.
A small business loan is good debt, but you should understand what you’re getting for your money. What are the interest rates? What are the default terms? Often people can’t even tell me those things. As with any loan, you need to know what happens if you can’t repay the money. What happens if you default and your wife guaranteed it? The government can garnish her wages. They can take your tax refund money. If you don’t understand the terms, you don’t understand what the exposure is for your business.
Funding from private investors is considered good debt, and a good opportunity. It proves that someone is willing to invest in your business. Take the time to write a solid business plan if you’re going to seek out investment money. That means looking at your business health and having a backup plan financially. They’ll want to be repaid: how you plan to do that? And in what time period?
Consider what your debt will look like going forward, in case you plan to borrow more at a later date. Another creditor may look at those loans and see that there are priority lien holders against you. They may think, ‘I could get nothing if I lend you money and you’re unable to repay it.’
EO: Can lenders take a business owner’s personal finances into consideration?
LT: The truth is that banks are not just looking at the business but at the owner as well. They want to see that you’ve paid your own bills on time and that you’re not overextended with credit cards. Your available credit versus what you owe is certainly going to be an issue with creditors.
EO: How much debt should a business take on?
LT: You want to keep the debt for your business below 25 percent of what is available to you. But I don’t think you can expect to keep the percentage that low early on. When you’re starting out, especially if you took out a business loan, you may have significant debt, and that’s normal. For some businesses, like restaurants, it can be that way for a couple of years. Paying back those loans should be a top priority, so keep that ratio in the back of your head. As you expand, keep asking yourself if it makes sense to still have those loans. Are you being negatively impacted by the amount of debt? A few years down the road it might make sense to pay off an old loan that carries a higher rate or unfavorable terms. You could take out a new loan with better terms.
EO: Can a business borrow its way to growth?
LT: You have to break that strategy down as a business owner and decide how it’s going to impact you. What are your real costs? You can borrow to grow, but you have to delve into the cost for each item and each employee. How much will it decrease costs to train your employees and maintain your equipment? I don’t think people do the cost analysis as detailed as they should. That’s a mistake small business owners make a lot.
If you’re borrowing to grow your business, that’s different from borrowing to save or maintain your business. When you have a growth strategy that means you have a plan in place to pay back the loan. If you’re adding more debt to a strained cash flow process, you’re putting yourself into further risk. A business looking to grow is much healthier.
Disclaimer: Since the details of your situation are unique, you should always seek the services of a qualified professional for advice specific to your business.