Debt is often used as a form of capital when starting a business. It's not just in the beginning stages of a business either. Sometimes small businesses take on debt in the short term to cover things like a new investment that is needed or to make payroll if they are experiencing cash flow issues on a given month.
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Common forms of small business debt include small business loans from traditional lenders like banks, loans from alternative lenders that can be found online, and business credit cards.
What to Know Before Taking on Debt
While taking on small business debt as a form of capital is pretty normal (even a lot of successful businesses have some debt), there are a few things you need to know before deciding to take on small business debt.
The last thing you want to do is take on debt and then having it backfire on you. That's why you need to see small business debt as a calculated risk. Here are some things to keep in mind:
Don't take on more debt than you actually need (which means crunch some numbers before hand).
Know exactly what the repayment terms and fee structure is like for the form of debt you've taken on. For example, alternative loans have interest rates that are comparable to that of credit cards but you often times have to pay it back in either six- or twelve-month terms.
Know what kind of debt you have access to. According to a survey by the National Small Business Association, many business owners claim that business credit cards are easier to get their hands on than a bank loan. If you know it's unlikely that you'll qualify for a traditional loan, seek alternatives.
Have a plan for how you're going to make the money back. Otherwise, you just took on debt for no reason.
How Much Is Too Much
One question a lot of business owners have about small business debt is how much debt is too much. The answer varies by industry, so you may have to do some research to see what's considered normal for your business.
That said, it's helpful to know what your debt to equity ratio is. This can help you determine if your current sales aren't enough to cover what you owe and if you need to make some changes.
All you have to do is to divide your total debt by your total equity. So if your equity is $200,000 but you owe $400,000, then your debt to equity ratio is two to one. That means you for every dollar you own in the company, you owe $2 to creditors. Not an ideal situation to be in and taking on more debt would be a tough row to hoe for a small business. With a larger company you may find value in taking more debt on since the interest is deductible.
Tips for Managing Small Business Debt
The good news about managing small business debt is that it's similar to managing personal debt — the same concepts apply. The reason for this is that small business debt is usually shouldered by the owner. So even though it's technically "business debt," it's still your debt.
Here are some strategies to implement when managing small business debt:
- If you're using a business credit, try to pay it off in full each month.
- If you're carrying debt on a small business credit card and can't pay in full, pay far more than the minimum.
- If you've taken out a loan, the payments are likely fixed. Just pay it like you would any other bill.
- If you've realized your debt to equity ratio is too high, find ways to increase revenue so you can more quickly pay off the debt.
When used responsibly, small business debt can help you move your business forward. The key is to know what you're getting yourself into and then how to manage the debt once you've taken it on.