Taking on debt, such as a loan or a line of credit, can provide a business with the cash it needs to expand or fund a new venture. Here’s what you need to know about when and why it can make sense to take on business debt.
When is it a good idea to take on business debt?
Businesses can benefit from taking out loans or opening new lines of credit under these circumstances:
When seeking resources to help grow the business. It takes money to make money, and a small business loan can help business owners pay for an expansion when they don’t have the resources to fund it on their own. The funds can be used to broaden the company’s line of products or services, finance a move to a larger location, fund a marketing campaign or hire additional staff.
When trying to build credit. Taking out a small loan or opening a new line of credit can be a great way to build a credit profile for a business and to strengthen its relationship with financial institutions. Small loans and lines of credit can help a business prove it is responsible and trusted to repay its debts. This will open doors to larger loans that may be needed in the future.
Why is debt often a preferred source of funds?
Here’s why debt can be a preferred source of funds for a business, as opposed to selling equity in the company:
It has lower financing costs. Unlike equity, debt is limited. Once the loan is paid back, the business owner can forget it ever existed. On the flip side, selling equity in a company generally means forking over a part of the profit for as long as the business exists.
It provides tax advantages. Business debt can decrease a company’s tax liability by lowering its equity base. As an added bonus, interest on business loans and lines of credit are usually tax-deductible.
It mitigates risk. Taking on debt to access funds instead of selling equity lowers the company’s risk in the event that the business does not succeed.