Forget flying or invisibility, lending can be a superpower for businesses. In the context of our blog, debt refers to borrowing money and, when done responsibly, it can help you achieve your financial goals or objectives – whether that’s an office upgrade or investing in growing your business.

Here we separate the fact from fiction and give you our top tips to make lending work for you.

  • ‘Is all debt bad debt?’. Absolutely not! The key to using debt lies in why you want it and how it can provide benefits to you in the longer term. Used wisely, well structured, strategic borrowing can lead to significant growth and wealth creation opportunities.
  • ‘Debt equals failure’. This is definitely not the case! As long as your business remains healthy, borrowing money in a responsible manner can fund expansion, assist in managing cashflow or to take advantage of lucrative opportunities.
  • ‘Business growth is impossible without debt’. It’s true that debt can certainly accelerate growth but it’s not essential. It might make better sense to rely on the retained earnings of the business or raise equity to finance growth, but this may take a little longer.
  • ‘Debt equals loss of control’. Wrong again! Unlike equity financing where you may have to ‘give away’ ownership of part of your business, an appropriate and manageable level of debt allows you to maintain control over your business decisions.

So, we’ve established that not all debt is bad, but how do you distinguish between ‘good’ and ‘bad’ debt?

Good debt, backed by a well-structured business appraisal, can be used to fund investments that provide long-term returns, such as plant and equipment, working capital and property. It allows operations to be scaled up or to expand into new markets and provides clear and affordable repayment plans at agreed interest rates. In certain circumstances, the interest costs can be tax-deductible which reduces your net borrowing costs.

Debt can prove to be bad when it’s used for purposes that do not clearly support financial goals and objectives, like a luxury office renovation or excessive marketing without a clear return on investment (ROI). Whilst a place may exist for short term higher interest rates, arranged loans to assist short term cashflow problems may not be the best funding instrument for medium term investment projects. Unplanned borrowing may be bad, particularly if it hasn’t been pre-arranged with your lender or there’s no easily identifiable source of repayment. Also, this may not address the root of the problem, and it may be that suitable funding is required to cover short-term working capital needs.

So how do I decide which debt is best for me?

There are many forms of debt available and making sure you’re well informed is critical. Ask yourself five key questions:

  1. What do you need the debt for? Any loan needs to support a measurable goal, for example boosting revenue, cutting costs or improving operational efficiency.
  2. Can I afford the repayments? Look at your cashflow and potential ROI to be sure that the repayments don’t place financial strain on your business.
  3. Check the repayment timeline. Think carefully about how long you’ll need the loan. Opt for short-term loans or revolving credit such as an overdraft facility for working capital and longer-term loans for large assets where repayments can be geared to the asset’s useful life.
  4. How’s your debt-to-equity ratio? Too much debt can affect financial flexibility so avoid over-leveraging.
  5. Is the lender reputable? Always work with established lenders who provide clear terms, transparent fees and flexible options.

Forms of available debt and their pros and cons.

Once you know what you’re looking for, it’s time to explore all the options available – as well as the pros and cons of each.

  1. Term loans. These are fixed, lump sums borrowed from a lender and repaid over a set period of time.

    Pros

    • Predictable repayments.
    • Opportunity to tailor the loan to meet your needs.
    • Suitable for funding larger, long-term investments.

    Cons

    • May include prepayment penalties or fees.
  1. Credit lines and overdraft facilities. This allows for flexible borrowing where a business or individual draws funds as and when needed – up to a certain limit –only repaying what’s used.

    Pros

    • Interest is only paid on the amount borrowed and period its used.
    • Flexible access to capital for short-term needs.
    • Can help manage short term cashflow fluctuations.

    Cons

    • Needs careful management to avoid overuse or being used to fund capital projects.
    • May be subject to annual renewal and fees.
  1. Equipment or vehicle financing. This is where you take out a loan or higher purchase agreement, specifically for buying equipment or vehicles.

    Pros

    • The equipment serves as collateral which lowers the risk for the lender and hence, is typically reflected in a lower interest rate.
    • You can spread the cost of high-value and/or depreciating equipment over time.

    Cons

    • If you don’t repay the loan, you risk losing the equipment or vehicle used as collateral.
    • This only covers specific assets – not general expenses.
  1. Trade credit. Here, suppliers extend payment terms for goods and/or services which allows delayed payment.

    Pros

    • If terms are met, there’s typically no interest to pay.
    • There’s no requirement for an immediate cash outlay.
    • It can strengthen supplier relationships when used responsibly.

    Cons

    • If you miss payments, financial penalties may apply, or your trading account may be stopped.
    • It’s limited to businesses with strong supplier relationships.
    • It can strain supplier relationships if mismanaged and/or operated outside of agreed terms.

Conclusion

As you’ve seen, debt isn’t the enemy. On the contrary, when used responsibly and managed wisely, it can be a strategic ally. Remember to borrow for growth, not survival; ensure the potential return on investment outweighs the costs of borrowing and maintain the right balance by retaining a health debt-to-equity ratio. Remember failure to make your agreed repayments can have an impact on your credit file and may affect your ability to borrow money in the future.

At Close Finance, we specialise in providing individuals and businesses with tailored lending solutions. We understand how to manage debt effectively, allowing you to grow with confidence. We’re here to help ensure that by borrowing responsibly, debt can be your superpower.

Ready to take the next step? Get in touch today.