Using Debt Financing to Grow Your Business

Small business owners can have conflicting attitudes to debt financing. This most likely stems from the way debt is portrayed in the consumer media–from concerns about national borrowing to consumers saddled by credit card spending and graduates weighted down by student loans. But many successful SMEs use debt financing to facilitate growth, suggesting that borrowing money responsibly can actually be a sensible thing for a business to do. Here are five reasons why:

1. It can be less expensive than giving up equity in your company

It’s often advantageous to compare the long-term cost of debt versus equity when thinking about finance.

Equity invariably means giving up a portion of your business and sacrificing both current and future value to fill a longer-term need. The cost of equity is sometimes unclear at the point of purchase and the process is more complex.

On the other hand, a good finance provider makes the cost of debt clear at the point of purchase. And if these costs are bearable for your business, the advantage of not having to surrender control of part of your company can be important.

2. It can support revenue growth by increasing working capital headroom

Suppose you lack the capital to buy inventory. The cost of goods sold is £50,000 and the revenue would be £100,000. Should you borrow £50,000 at a cost of £10,000 to fulfil the order?  

In absolute terms, you’re making a £40,000 profit. In this case, the opportunity cost of avoiding £10,000 in interest is £40,000. Some business owners might be willing to pay £10,000 to make a £40,000 profit.

Of course, paying £10,000 on £50,000 is just an example. Finance can often be cheaper than this: indeed, at Growth Street, rates start at just 7.2% APR.  

If the opportunity is right, debt can often be a sound strategic choice as it can allow you to open up new growth channels. When assessing the cost of business credit, ask yourself the question: “Is the return from this investment higher than the cost of the debt available to me?” Whenever the return is higher, the debt is arguably worthwhile.

3. The corporation tax relief on interest lowers the cost of borrowing

Borrowing can have surprising benefits when it comes to tax. The cost of interest on borrowing actually reduces your taxable profit and, therefore, can reduce your tax bill. Because of this, the effective interest rate you end up paying is often lower than the headline interest rate.

On the other hand, if you raise cash from equity investment, you may need to pay off that equity holder in the form of dividends, which are not linked to corporation tax relief.

Leveraged buyout firms have long used borrowing money as a strategy to improve their returns on equity investments. SMEs, too, can use these measures to improve finances and fund business growth.

4. Borrowing reduces hoarding of cash and profits, facilitating growth

Hoarding cash harms a business’s ability to invest profits and generate additional returns, which can be important when growing a business. If you hoard cash from a busy period, anticipating a future pinch point, your profits may not be reinvested for growth. While this can be prudent, businesses that want to optimise for growth may benefit from deploying surplus cash.

Growth Street’s flagship working capital facility, GrowthLine, lets you draw down funds and make repayments as often as you like in any given month. This can help businesses which trade seasonally as having access to cash when you need it, and being able to repay when you don’t, can be important.

5. Debt can improve financial discipline and business efficiency

If debt is managed well and you’re making regular, on-time payments, you can increase your business’ credit score. This can ultimately increase a business’s overall spending limit, lower their future interest rates, and help them allocate their financial resources efficiently. While businesses may not take on debt for this reason alone, it might be a positive side effect.

There are, of course, situations when it doesn’t make sense to seek finance through debt. However, if you approach debt in the right way, it can be used as a strategic tool for growing a business, and it can be a cheaper financing option than other alternatives.  In today’s competitive environment, it’s advisable to shop around for the sources of finance that closely fit your needs. Head here for more tips on financing your business through debt. And learn more about our business financing product, GrowthLine, here.

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Written on in Borrowing
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