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What's a Healthy Level of Business Debt?

By Matt D'Angelo
Business.com / Accounting / Last Modified: August 8, 2018
Image credit: wutzkohphoto/Shutterstock

Creating a plan and working with a professional are two crucial things you can do to ensure you're taking on a healthy level of debt.

Debt is a necessary part of any business journey. By taking loans or seeking financing, you're giving your company the fuel it needs to grow. The key, however, is understanding 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, said financing is a crucial ingredient in the growth of many companies.

"Access to capital," he said, "can be the difference between explosive growth, linear growth and the death of your business."

At the heart of good and bad debt are your own aims as a business owner. While it may sound obvious, it's important to only take on debt to accomplish goals, spur your company forward or provide the necessary fuel to build your business. It can be easy to take on debt to accomplish one thing and not have a plan for the rest of the money, for example.

"Debt should be used to extend 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." [Interested in getting a loan for your small business? Check out our breakdown of the best small business lenders in 2018.]

Healthy debt isn't a defined amount

The amount of debt that's "healthy" for your business to take on will vary widely depending on your own 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 is the co-founder and CEO of Triplebyte, a hiring platform geared specifically toward software engineers and startups. He said 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," he said. "Bad debt is money you spend without understanding how it impacts your business."

Taggar and Triplebyte explored some loan options but ended up raising funds through an equity round. This kind of financing supports Taggar's point – it was exactly what his business needed, and he had a realistic plan for how to build his business with the capital. Ory also weighed his options but ended up getting funding through venture debt, which is provided by 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," he said. "The ability to expand your business ahead of cash flow is critical to growth and can provide a competitive edge itself."

Creating a plan

Creating the right plan for your business may involve speaking with a financial professional or hiring a chief financial officer. If you're not a financial expert but are looking to take on debt to grow your business, these professionals can help you move in the right direction.

"Review [your] financials holistically with a financial professional at the end of each month," Taggar said. He also said it's important to do more than just look into the numbers – by diving into fundamental business metrics, you can assess your business's condition and lay out a realistic financing plan.

Ory said Phone2Action has a CFO and accounting department that helps break down the company's financial situation and ensures they're moving in the right direction. If you don't have the funds or ability to work with a professional, do your best to realistically assess your situation. If you make a solid plan for the capital and properly assess your growth, you can successfully raise funds. Taggar warned 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," Taggar said, "[but] growth slows and you're slow to react, you can be left in a fatal situation."

Bottom line

If you've taken on debt that you can no longer pay, it's important to act fast and stop spending money. This is fairly logical and standard protocol. Both Ory and Taggar said by tightening up and getting financially sound, you can better your position and become less reliant on debt.

"Start cutting costs immediately," Taggar said. "It's a painful process, but the longer you delay it the worse a position you'll be in."

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