Debt is an important and sometimes misunderstood part of a business’s balance sheet. Owners may mistakenly assume all debt is bad and should be avoided. The truth is more complex.
The key to good debt is to have a strategic reason to take on debt–don’t just borrow because rates are low–seek out lenders offering terms that work for you. In today’s low-interest environment, there can be pressure to take on debt without thinking long term, but the structure of the loans may be variable or not in an owner’s best interest. Work with an advisor to take on good debt that serves a purpose. Here are some ways debt can be useful:
Use good debt to improve your balance sheet
Take advantage of low-interest rates to refinance older, higher interest debt. This may also provide an opportunity to restructure debt to serve your business strategy–lower interest rates and extend terms to free up cash flow and increase liquidity, or you may be able to pay the debt off sooner. Some companies are using debt to buy back stock or as an alternative to issuing stock because of the low cost of debt.
Borrow to expand or improve your operations
Debt is often a critical ingredient in expansion, whether by acquiring another business, adding territory, upgrading equipment or facilities, or hiring. The key is to have a good plan for using the funds and ensure the expansion or improvement will generate cash flow to cover the repayment of the loan. This may seem obvious, but when interest rates are low, the temptation to obtain and spend money can lead decision makers to borrow first and ask questions later.
Protect your business from the unexpected
Debt played an important part in keeping doors open and employees paid during the COVID-19 pandemic, and many owners are rethinking what their financial safety net should look like. Having available lines of credit to weather short-term shocks is one strategy; another involves the balance sheet refinements described above to cushion cash flow or increase cash reserves.
Seek out special lending opportunities for long-term improvements
The U.S. Small Business Administration and other government agencies sometimes offer special, highly advantageous loan programs to support initiatives. Examples include low-interest, long-term loans or waived fees for construction and renovation projects. Programs and criteria vary, which underscores the importance of working with experienced SBA Preferred lenders who can make a good match for your business.
Use debt to transfer ownership of the business
There has been a notable increase in business ownership transfers in the past year, as some owners are retiring while others are using available liquidity to acquire businesses. There has also been an uptick in the use of employee stock ownership plans (ESOPs) to transfer business ownership to its employees. Whether selling, passing down, or changing the structure of a business, debt often plays a critical role in ownership transfers.
Whatever the strategy behind your debt, be sure to work with a trusted partner who understands your business. Alerus has worked with businesses of all sizes for decades, with a focus on helping organizations position themselves over the long term to realize their purpose and vision. Alerus business advisors help owners keep a close eye on their fundamentals and understand the implications– and opportunities–that borrowing presents. Talk to an Alerus business advisor today.
The information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Alerus does not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation. Alerus Financial, N.A. is member FDIC.