Borrowing to Grow: Dissecting Myths & Realities for Small Businesses
Understanding the Real Picture
Myth: You, as a business owner, should continue to borrow more capital as long as your business is “growing” (or, even worse, simply because you “can”).
Reality: This is potentially the most dangerous myth for a small business owner to believe. Unfortunately, it’s a myth that has been perpetuated by many short-term lenders, cash advance companies, and brokers that are singularly focused on a “completed transaction” and drive borrowers to cycle debt through high cost renewals instead of the long-term success of your business. Just a few weeks ago, I read a blog by a competitor (who claims to pride itself on merchant relationships and transparency) that stated that you, a business owner, should keep borrowing money as long as you are continuing to “grow your business”. That is just flat out wrong and, frankly, is a dangerous statement. It doesn’t matter how fast your revenue is growing if you continue to borrow money at a cost that exceeds your revenue growth rate. Here’s the right answer: only borrow money if (a) you know your return on capital will be higher than the cost; and/or (b) you have a plan in place to pay the loan or advance back without putting undue stress on your business. I’ve watched too many good small businesses fall down the rabbit hole of debt until they are so over-levered they go out of business; and so many of these businesses could have avoided that fate by understanding when and why they should borrow money. Or they’ve come to Breakout Capital to lower their debt payments through our revolutionary consolidation product. But here are some important pointers to avoid this fate in the first place:
Only Borrow Money if the Return (or Benefit) from that Capital is Greater than the Cost
For example, Joe owns a pizzeria and decides they need a larger oven that will allow Joe’s business to cook more pizzas at a single time. Joe calculates that the new oven will generate $20,000 in additional net revenue (profits) over the next two years through improved operational efficiencies. In Joe’s situation, a short-term loan or cash advance could be a great solution as long as the total cost is less than $20,000 and Joe doesn’t unnecessarily borrow additional, high cost capital; just because a lender tells you that you are “up for renewal”, that doesn’t mean that you should borrow more money. I also understand that many small businesses will encounter hiccups, rough patches, or make mistakes and will need money to get their business back on track (such as non-paying customers, a broken truck, a flooded kitchen, or a failed marketing campaign). In those instances, borrowing money may be a necessity and the return will likely not outweigh the cost. But that doesn’t mean you should make a hasty decision. And it brings us to key consideration number two.
Only Borrower Money that You Know You Can Repay
Given the nature of the product (short repayment periods), short-term capital will always carry a higher annualized cost than three or five-year loans. The ups and downs of running a business can be stressful, and there are many unsavory brokers and lenders out there that will look to take advantage of a tough situation to push excessively high cost capital on a struggling business. Don’t listen. If your business ran into a few bumps, you still need to take the time to step back and evaluate your options. If you do decide to take a loan or cash advance, make sure you carefully read the contract, understand the payback terms, and ensure you have developed a plan to repay the capital. And most importantly, don’t just borrow more money because you “can”.
If you do decide to borrow money or take a cash advance, here’s one final pointer: only borrow money after evaluating all of your options.
Instead of speaking with a broker that may drive you to a higher priced product because it pays a higher broker commission, consider a marketplace like Fundera or Lendio where lenders will compete for your business. This will help ensure you get the best possible product at the best rates for your business. If you are working through a broker, make sure you ask for several potential alternatives and ask how much the broker is being compensated on the transaction; every dollar paid to a broker will increase the cost of your capital accordingly, and brokers can frequently charge fees to lenders in excess of 10% to 15%. Once you think you have found the right lender, you should explore sites such as TrustPilot to ensure customer reviews on the lender are positive.
Breakout is committed to responsible funding. We believe it is better for you to keep your business and grow it responsibly than set it up to fail with insurmountable debt. Please contact us today if you’d like to partner with us.
