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Financing can accelerate any business' growth, but approaching it properly is critical.
Using business debt judiciously can be an excellent way to grow your company. However, when utilized poorly, debt can irreparably harm your organization. Understanding the difference between good and bad business debt is critical to use debt to your business’ advantage.
We’ll explain good vs. bad business debt and share strategies for ensuring a healthy debt level and getting your business out of debt.
Debt is a necessary part of most business journeys. Businesses use debt to improve cash flow, pay suppliers, run payroll and more. Taking loans or seeking financing can be part of a business growth mindset.
However, business owners must understand debt, healthy loan practices and the difference between financing that can result in explosive growth and the kind that cripples your business.
Jeb Ory, co-founder and CEO of social advocacy platform Phone2Action, agrees that financing is a crucial business growth ingredient that must be approached thoughtfully. “Access to capital,” Ory noted, “can be the difference between explosive growth, linear growth and the death of your business.”
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It’s crucial to understand your debt type. The two types of debt are consumer debt and business debt.
A business owner’s goals are at the heart of good and bad debt. Taking on debt can be positive when accomplishing goals, spurring your company forward or providing the necessary fuel to build your business.
“Debt should be used to extend the runway and help businesses make purchases that they couldn’t normally make if it makes them more competitive,” Ory said. “The type and amount of debt should be directly linked to the type of business.”
Good business debt examples include the following:
Bad business debt examples include the following:
A “healthy” debt amount will vary depending on your situation. Instead of reaching for a defined number, view healthy debt as debt tied to specific growth plans and strategies for your business.
Harj Taggar, a group partner for Y Combinator and co-founder of Triplebyte, says having a defined plan is one of the most important aspects of handling debt. “Good debt is tied to something solid with a clear plan for why it’s helpful,” Taggar explained. “Bad debt is money you spend without understanding how it impacts your business.”
Taggar and Triplebyte explored loan options but ended up raising funds through an equity round. This funding infusion was precisely what his business needed and he had a realistic plan for building his business with the capital.
Ory also weighed various financing options but got funding through venture debt via a specialized bank that serves small software-as-a-service companies. “Technology has flattened barriers to entry, and it’s easier than ever for new companies to enter a market,” Ory noted. “The ability to expand your business ahead of cash flow is critical to growth and can provide a competitive edge itself.”
Creating the right plan to amass healthy debt for your business may involve speaking with a business accountant or financial professional or hiring a chief financial officer. If you’re not a financial expert but are considering taking on debt to grow your business, an expert finance team can help you move in the right direction.
“Review [your] financials holistically with a financial professional at the end of each month,” Taggar advised. He noted that you shouldn’t just look into the numbers. Instead, dive into fundamental business metrics to assess your business’ condition and lay out a realistic financing plan.
If you don’t have access to ― or a budget for ― financial professionals, do your best to assess your situation realistically, create a solid plan for the capital and assess your growth properly. However, Taggar advised companies to be wary of situations where projected growth doesn’t align with the debt.
“If you took on a level of debt based on growth assumptions that proved to be optimistic [but] growth slows and you’re slow to react, you can be left in a fatal situation,” Taggar warned.
If your business has taken on more debt than you can handle, here are some ways to dig yourself out of bad business debt:
Jennifer Dublino contributed to this article. Source interviews were conducted for a previous version of this article.