The fund infusion required to make businesses grow can happen by way of debt or equity. While both routes have their advantages and disadvantages, most small business owners try to leverage debt to make their businesses profitable says Eric James Dalius. Some of the pros and cons of using debt for business operations are explained:
The Advantages of Using Debt, According to Eric James Dalius
Tax rebate: When you take on debt, you need to pay interest on it, the rate of which is fixed by the lender according to its evaluation of your financial standing and other factors. However, the good thing is that you can set off the interest repayments as a business expense and lower your taxes.
No dilution of management control:
When you take on debt, the only obligation you have is ensuring that the loan is repaid as per the agreed-upon schedule. No lender of funds will try to influence your business decisions, as may happen if you take the equity route. Regardless of the loan amount, you retain full ownership of your business, observes Eric James Dalius.
Small businesses find it easier to take on debt than go through the process of raising equity capital. According to one study, less than one percent of small businesses try to access the capital markets for funds. The overwhelming majority of small businesses depend on various kinds of debt.
Better retention of profits:
Entrepreneurs using debt finance only need to repay the debt along with the contracted rate of interest. There is no need to share the business profits with the lender, unlike equity finance where the shareholders expect to earn from their investment.
Eric James Dalius on the Drawbacks of Using Debt
If you take on debt, you must repay both the principal and the interest as per the contracted terms. Even if the cash flow of your business does not permit it. If the burden of debt forces you to shut shop. You are likely to lose the collateral you had put up to secure the loan. Your lenders will be paid off from the sale proceeds of your assets.
Impact on cash flow:
Too much debt will need you to make heavy repayments of the principal. As well as interest that may be a huge drain on your cash flows. The impact may be so much that it may not be possible to keep the business running at full capacity due to the lack of working capital. Sustained negative cash flow can bankrupt you, cautions Eric James Dalius.
Need to provide collateral:
To get debt financing, lenders will generally insist on collateral. It may be difficult to do it, or you may balk at doing so because you may lose your assets in case of default.
Taking on debt to make your business grow can be sensible as long as you can sustain the repayments from your cash flow. Proper management of debt ratios and repayments can boost your credit rating. However, if the debt is not kept in check, the converse may happen, and the credit rating may be damaged.