Marina Thomas is a marketing and communication expert. She also serves as a content developer with many years of experience. She helps clients in long-term wealth plans. She has previously covered an extensive range of topics in her posts, including business debt consolidation and start-ups.
When Using Debt Could Benefit You In Your Business Venture
According to a recent report on small business trends and statistics by Guidant Financial, aspiring business owners found access to capital to be the biggest hurdle. Apart from the ability to make down payments and poor credit scores restricting debt-based financing, other issues that were cited as being barriers to financing included lack of knowledge about the various funding options, and a reluctance to use debt to invest in the business.
However, as recently as May 2018, Forbes reported that “Loan approval percentages again rose at big banks ($10 billion+ in assets) in April. More than one-quarter (25.7 percent) of small business funding requests were granted, continuing a prolonged upswing that has been in effect for the past few years. The same report goes on to observe, “Small banks are particularly active in processing SBA loans, which mitigate risks for lenders, thereby making it more attractive for them to lend to startups and entrepreneurs who may not have a long history of timely credit payments.”
Here are some reasons why entrepreneurs should consider using debt for investing in their businesses:
Allows You to Retain Ownership of the Business
The biggest fear that a small business owner has on funding is that the investor will want a slice of the pie even before the business has attained a reasonable valuation. With the equity-financing route, it is not unusual for entrepreneurs to have to part with a substantial part of the equity to get in investor funds that are crucial to the growth of the business. With debt financing, there is no need to give away a part of the equity. At the most, you may have to offer items of plant and machinery, vehicles, real estate, or accounts receivable as collateral to secure the loan, however, you run the risk of losing that asset only if you default on the loan repayment. There is no tugging at the ownership of the business even in the case of a loan default.
Permits Retention of Control of Company Management
When you need to offer equity in order to get investments into the company, you also tend to lose some amount of control over the management of the business. Even when you have ownership control, you may have to seek approval of the equity shareholders to a large and diverse list of items ranging from fresh investments, key recruitments, and even vendor selection. Generally, equity investors want to have some say in the way the company is managed and vital decisions are taken when they have invested substantial equity. However, you have taken a loan; lenders are not interested or entitled to have a say in the way you manage your business. The business owner has no compulsion to take approvals from the lender for any operational decision-making. Lenders are happy not to interfere in any manner in business operations as long as the loan repayment is made as scheduled. Businesses owners who are unable to manage their debt effectively can approach reputed debt settlement companies like Nationaldebtreliefprograms.com.
Tax Benefits Accrue On Loans
One of the biggest attractions of using debt to invest in the growth of the company is that the interest payable on the loan qualifies as a business expense so that has a beneficial effect on the amount of tax payable. The higher the tax bracket the company is in, the bigger the tax break. The interest expense is tax deductible regardless of the type of debt so it does not matter whether you are considering a term loan or a line of credit. The only riders put in by the IRS are that the loan should have been taken for business purposes only, that the business owner is legally liable to repay the debt, it is the intention of both the borrower and the lender that the debt is repaid, and that the lender and the borrower have a creditor-debtor relationship. Apart from the interest on the loan funds, other charges that may be levied by the lender for either financing or refinancing by whatever name such as loan charges, origination fees, documentation charges, premium or discount charges may also be claimed as legitimate business expenses and set off against the income of the business for tax purposes. Since there may be certain limitations to the setoff of the expense, it is best to seek advice from a professional accountant.
Effective Rate of Interest Is Reduced Due to the Taxes
Even though on paper, it may often seem that the rate of interest on debt financing is high in comparison to other financing options, you will need to take into account the reduction of the interest rate due to the application of taxes. For example, if a business that is in a tax bracket of 25% takes a loan at a coupon rate of 14%, the effective rate of interest amounts to only 10.5%. Thus 10.5% is the rate that should be used in financial projections involving debt funds. You will find that due to the application of taxes, the profitability of the business venture actually improves.
Relatively Easier to Access by Small Businesses
A lendedu.com study confirms what small business owners have known all along; in 2015, bank loans were still a major source of funding for small businesses. While banks loans accounted for nearly $600 billion, angel and venture capital provided only around 2% of funding requirements of small businesses in the same year. Even the SBA confirms that while 87% of small businesses accessed debt funds, only 2% reported venture capital as a source of funding. One reason, of course, is that venture capital funds are keener on spotting and funding the next ‘unicorn” business. While the process of issuing bonds is very difficult to comply with by small businesses, they can always look around for loans.
Even as is very apparent that using debt can be a very attractive and viable proposition for small businesses compared to alternative financing methods, taking loans and repaying them on time also helps to build the all-important business credit score that will make access to funds easier in the future. A good credit score is a demonstration to all, including lenders and vendors that your business is being run responsibly.
If you’re interested in writing a guest post for The Money Mix, check out our guest post guidelines.
Note: The Money Mix hosts guest posts as a way to further diversify and amplify the personal finance community. We don’t agree with everything written in our guest posts, nor do we endorse the author or ideas expressed in the post.
The Money Mix is a resource dedicated to money and personal finance. Our mission is to create a healthy conversation about strategies to make and save money, build wealth and how to achieve life-changing goals through taking control of your life.