Should your company have debt is a question that is commonly asked by many business owners, particularly those new to the world of business. While it can be a scary thought to think that your company is in debt, sometimes it is necessary, and even beneficial, to a company to be in debt. Below we examine this issue in more detail.
What are the benefits of having debt for your company?
One huge benefit that having debt will have for your company is that it can be used as leverage to reduce the return on equity (ROE). If you raise the capital that your business needs solely through giving out equity to investors, then the majority, if not all, of your profits in the first few years of business will be returned to the investors for their investment.
For example, if you need £1 million in capital to get the business going, raise this through investment, and then make £100,000 profit in your first year, this will be returned to the investors. This could, effectively, leave you at £0 profit.
The other option to consider is splitting this up between equity and debt. You could raise £500,000 through investment, and the other £500,000 through debt. If your business makes the same amount of profit in a given year, the amount of profit that needs to be returned to investors is halved, leaving you with profit to spend as you see fit.
Finally, the greater stake that you keep in your company, the greater say that you have in how it is run. While investors will be able to give you large sums of cash quickly, they will ultimately gain control in your business and will be able to influence how it is run.
What are the drawbacks to having debt for your company?
However, it will not be as clear cut as this for all businesses. It must be remembered that you will only need to pay your investors a return on their investment should you make a profit; if you do not then you will not be at a loss. If you are an early stage SME, chances are you may not be in the green for a couple of years at first.
However, you will still be expected to keep up debt repayments and your debt will gain interest, so should you not be making a profit you could be in real trouble.
The flip side to this is that the repayments you make to your debt loan will be much less than to your investors, and your debt interest expenses are tax deductible, providing a further financial benefit to your business.
Should you take out debt for your company?
If you are reading this article, then the reality is that you do not have enough cash yourself to get the business going. Investors and debt provide two solid, reliable means for getting your business exactly where you want it to be.
Both offer pragmatic and workable solutions, and if used in conjunction can allow you to gather the cash you need while still maintaining control over your business. If you expect your company to be successful, then the greater the stake that you maintain in your business the bigger the rewards further down the line.
However, as with all debt, be careful when approaching it and be sure to conduct thorough research, business forecasts, and plans beforehand. Should you fail on debt repayments you could find yourself in a messy financial situation quite quickly. But with careful management, taking out debt on your company is a savvy and often-used approach that has allowed many a successful business to grow.
Should you be interested in reading more on the debt versus equity debate, take a look at this TIME article When Is It a Good Idea For a Company To Take On Debt?