Starting a business takes money. One way or another, you’re going to have to raise capital, and there are several ways to do it:
- Relying on personal savings (which take time to build and will almost never be enough);
- Raising capital through investors;
- Taking out a small business loan.
Each method has its own advantages and pitfalls, and while debt is often pilloried by celebrity investors, it can actually make a lot more sense for entrepreneurs than other financing avenues.
The Dangers of Starting a Business with Debt
First, the bad news. One of the big dangers about starting a small business with debt is that the founder’s personal finances are often not separated from the business. Even if the business is incorporated, banks tend to require a personal guarantee or even collateral for a small business loan. When your personal finances get involved, bankruptcy can be on the table.
Running a Business on Debt
Starting a business with debt is one thing, and it can actually cost you less than finding investors. Running a business on a line of credit is another thing. If you don’t have enough money coming in, you can wind up digging yourself in deeper and deeper.
When you don’t have cash, you don’t have cash. You need to do something to pay your employees, suppliers, rent, etc. It can be easy to let suppliers’ invoices stack up, credit card bills go unpaid, and utilities go into debt collection.
Once you reach that point, it may be time to find debt help from a Licensed Insolvency Trustee. These days, there are more options than bankruptcy. A consumer proposal may be a viable option for settling unsecured debts. Find out more about insolvency options at Debthelp.ca if your business has landed you in personal debt.
The Benefits of Debt Financing
Now that you know what can go wrong, it’s time to find out why debt financing could actually be better than finding investors. If your business is a success, debt financing prevents dilution, or losing more and more of the equity in your business in exchange for short-term financing. Equity is for life, but debt can be paid off.
Take this example: you start a company and have a choice to either borrow $100,000 or take a $100,000 investment.
In the course of 6 years, your company grows ten times over. That $100,000 investment now costs you $1 million in shareholder equity.
By comparison, look at the $100,000 loan. At a 10% interest rate over 6 years on a deferred lump sum payment at maturity, the total cost of the loan is $179,000, or $821,000 cheaper than taking the investment.
In a successful business, investments cost founders a lot more than debt.
Have a Back-Up Plan
If you are taking on personal debt to finance your dream of starting a small business, make sure you have a back-up plan. Any business has the potential to fail, including yours. Sometimes factors out of your control mean you need to shut down. Have a plan for when it does that allows you to pay back the new debts you’ve accrued, such as going back to a previous career or cutting back your expenses.
Debt financing can make a lot of sense, as long as you’re prepared.