Starting a business can be very exciting. You begin with ambitious goals, many ideas and overwhelming to-do lists. But, there is one question that will hit you early on in your journey and it is a question that doesn’t have a straightforward answer: should you take out a loan to fund your business? Getting into debt so early on is a double-edged sword. On one hand, it will provide the capital to launch, grow and flourish; on the other hand, it will tie you to regular repayments and financial risks. Is debt a smart move for you? Let’s look at the pros and cons.
The Pros of Business Loans
1. Ready Capital When You Need It
Many entrepreneurs don’t start their business with a huge pot of cash in the bank. Business loans therefore provide the funds to tool-up, take on staff, do some marketing and pay the bills. Without this, all the great ideas would go nowhere, fast.
2. You Retain Full Ownership of Your Business
Equity financing, where you relinquish a share of your business in exchange of funds, means that you don’t own 100% of the business, and often you won’t retain full control. A business loan, once paid off, doesn’t leave the lender with a claim to your profits.
3. Build Business Credit
Taking out loans and having a solid record of repayment will help establish a high business credit score. This can open doors for you to even bigger loans, more favorable terms and credit with suppliers in the future.
4. Tax Benefits
The interest on your business loans can be tax-deductible in many countries. This, obviously, reduces your overall tax liabilities and makes the cost of the loan more manageable.
5. Fuel for Growth
Debt, if used strategically, can be used to fund business expansion. This could be launching a new product or service, opening additional locations, or investing in new technologies. Many businesses have grown quickly because they were smart in their borrowing.
The Cons of Business Loans
1. Debt is a Commitment
A business loan isn’t just money for free. It comes with monthly payments (fixed or variable), regardless of your business performance. If revenues take a slump, the pressure on you to make repayments becomes even more intense, and stressful.
2. Collateral Might Be Required
Some types of loan require you to provide security on the debt with personal or business assets. If your business were to fail, you risk losing those assets, which could include your family home.
3. It’s Not Easy for Everyone
New businesses, especially those with no track record at all, often struggle to have the necessary qualifications for loans. Banks demand to see proven revenue, a good credit score, and a solid business plan. If you’re just starting out you might get rejected for the loan of your choice, or instead offered unfavorable terms.
4. Interest Can Add Up
Depending on the size and repayment period of the loan, you could end up paying many thousands in interest. High-interest loans (such as those from alternative lenders or credit cards) can escalate into a major financial burden.
5. Stress and Risk
Carrying debt can be very stressful and bad for your mental-wellbeing. It adds risk to your business venture, and can also influence how you make decision. Instead of focusing purely on business growth, you may then end up being forced into short-term thought patterns, just to stay afloat.
So, Is It Smart?
Sadly, there is no one-size-fits-all answer to this question. Debt can be a powerful tool, if used wisely. But it’s not for every business owner. Before you borrow, you should ask yourself:
- Do I have a clear plan for how the money will be put to use?
- Can my business reasonably generate sufficient income to cover all the repayments?
- Am I comfortable with the risk I am taking on?
If the answers are all yes, then debt could be the smart move to help you build your business faster and stay competitive. But if you’re unsure, or your revenue is unpredictable, it may be smarter to instead bootstrap your startup, or even explore grants or equity investors.
In the end, debt is inherently neither good nor bad. It’s how you use it that makes all the difference.
