Most businesses take on at least some debt at some point. Most need funding just to get started, and growth later can require additional debt. However, it can also be the undoing of your business. Most businesses fail in their first year and the ones that fail later often do so for the same reason, they took on too much debt and weren’t able to keep up with it.
Debt is a hole in the bottom of your checking account, both personally and in business. Debt is also definite, no matter how good or bad the business does, you still have to make the payments. This is great for banks, that’s why they usually have most of the biggest buildings in most cities. But it will kill your business. Just when you need to limit expenses and try to make it through the harder times, you will still have that payment that’s just as big as it was during your better times.
In investing, one of the best indicators of a company’s health is it’s debt. It’s actually really hard for a business to fail if it has no debt. It means they are financially healthy, flexible, and have limited their definite expenses which allows them to weather the storm or even take advantage of massive opportunities as they become available.
The housing crash and subsequent recession of 2008 was caused by debt. But what many people don’t realize is that people with little debt and lots of cash were able to buy lots of real estate at the time for cheap. Many made small fortunes and even built legacies on the discounted properties they bought during this time.
For small businesses, even though the numbers are a lot smaller than large corporations would have, it’s still vital to use debt sparingly and intentionally.
Many small businesses need a vehicle, and more vehicles to grow. But you don’t have to go out and buy a brand a brand new top of the line vehicle. One good side effect of so many other businesses failing is that you can often buy used vehicles and equipment for cheap compared to buying new. It’s not hard to find used white vans or restaurant equipment, there are whole businesses created for each because it’s THAT common.
I always tell people to think about what they need. They’ll say a new truck, I want a dually with a ton of horsepower and a nice new trailer to go with it. I ask them, is that what you need or what you want? Do you need that or do you need a truck capable of pulling a used trailer that weighs 2,000 pounds? That doesn’t require a new truck, a dually, or all the horsepower available on the largest truck. People get themselves in a mental corner because they fantasized about the nice new truck. Don’t let debt on a shiny new toy ruin your business.
I also tell people to find option C. They usually give themselves one or two options and neither is really right for them, but they don’t think outside the box and find an option C that’s actually even better than options A and B without as many downsides.
A Case for Debt
All that said, it’s hard to say debt is never okay or even the better option. One example is that debt is usually used for major purchases of fixed assets. Since these usually can’t be entirely expensed the first year anyway, that means if you pay for them in cash but can’t expense all of that actually spent cash, then you will have to pay taxes on cash you spent. If you can afford to do this, then do so. Staying out of debt by paying cash is best. But if you don’t have enough cash to pay for those major purchases and still cover all your taxes, then it may be in your best interest to spread out those payments to align better with the tax deductions. This is the type of analysis we regularly do for clients when they’re considering what to buy, when, and how to pay for it.