Borrowing offers undeniable benefit—even when there’s cash on hand.
You have financing options when growing your business.
When you’re ready to enter new markets, introduce new products or services, acquire a competitor or purchase real estate, your business is at an exciting crossroads. Even so, deciding how to finance the growth of your business is not an easy undertaking for most business owners.
Should you take a loan even when you have cash on hand? What are the implications of using lines of credit and bank loans to take your business to the next level? Small business debt can have a huge payoff for companies that know how to use it to their advantage. Here’s what you need to know as you consider how to best fuel the growth of your business.
Tap into unseen benefits.
As a positive side effect of opening a line of credit to grow your business, that same line of credit can also serve as an important safety net if something unforeseen happens. Suppose a fire destroys your inventory or a competitor brings a new product to market that’s better than yours. Will you be ready to deal with a cash flow interruption? If there’s ever a reason your business needs to slow down or suspend operations because you lack access to capital or are waiting to get approved for a line of credit, that can be detrimental to the short- and long-term growth of the business. This is especially true for seasonal businesses that bring in the bulk of their annual revenue only during specific months of the year.
Many entrepreneurs don’t realize that there are also tax benefits of business borrowing. The cost of interest reduces taxable profits and, therefore, reduces your tax expense. The effective interest you’re paying is lower than the nominal interest you’re paying. This lower cost of capital should be factored in when calculating the return from taking on debt.
Keep control of your business.
Some business owners, finding themselves in need of more liquidity than they have on hand to grow their business, will sell an equity stake to generate a cash infusion, rather than take a loan from a bank. In real terms, selling equity means someone gets to come in and benefit from the work you’ve already done. On the surface, it may seem like selling equity in your business is a cheaper way to finance your plans to expand. But remember, when you have an equity partner, you might not have debt on paper, but you have an equity partner to satisfy—permanently.
With a bank loan, you borrow the amount you need and repay principal and interest over time. Your loan repayment is a known expense that you plan for and pay, like any other bill. And unlike an equity investor, the bank only gets involved with your company if you fall behind on your payments. Once your debt is satisfied, the loan disappears and leaves you free to run your company as you see fit.
Extend your buying power.
Let’s say your manufacturing company has the opportunity to sign a contract worth $60,000. In order to meet the contract’s demands, you’ll need to install a new specialty machine that costs $30,000 and you don’t have the cash on hand. So you take out a $30,000 loan and pay around $6,000 in interest on it, leaving you a profit of $24,000. In this scenario, the cash flow at the end of the equation far exceeds your costs, so it makes sense to borrow money and purchase the machine. Plus, you now own an asset that will help generate additional profits in the future.
Or let’s say you’ve been renting your business location, and there’s an opportunity to buy it. Even if you have cash on hand to make the purchase, financing real estate offers clear advantages. Not only will you get the tax benefit from the interest deduction, but also, using a real estate holding company and an operating company structure can put you in an even more favorable tax position. Plus, buying property will build equity, strengthening your business’ balance sheet for when it comes time to apply for additional financing, or plan for the sale or succession of your business.
Plan for future sales.
Many successful businesses are seasonal. Let’s take for example a landscape design company in a four-season climate. Companies like these are often extremely profitable but struggle with balancing uneven cash flows through the slow seasons. Loans provide seasonal companies the cash flow to buy inventory during their off season.
In the case of one highly successful tennis pro shop in upstate New York, business is totally dead in winter, but the owner must order inventory four months in advance to ensure enough product is ready in time for the summer rush. Borrowing money in November helped secure enough inventory for the start of the warmer busy season to come.
In the case of transitioning a medical practice, financing can get a young up-start doctor the keys and loyal patient list of an established, retiring doctor. A banking relationship can help structure either whole practice buyouts or partial practice buy-ins, offering the financial support needed to prepare the practice to thrive under new or expanded leadership.
Regardless of industry, customized financing can put business owners in a position to enjoy a significant boost in sales and profits and repay any loans taken to finance growth quickly, after having accrued very little interest.