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Should You Start a Business If You Have Debt?

ByRebecca Wessell,
business.com writer
|
Dec 08, 2016
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> Finance
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The short answer is yes – if you're smart about it.

If you want to start a business, but have debt, you are probably wondering whether it’s a good idea. The short answer is that it can be — if you’re smart about it. Take a look at the questions below to help you assess your unique situation.

What is your debt situation?

Before you even begin thinking about your business, you need to be honest with yourself about your debt situation.

What type of debt do you have?

Not all debt is the same. Some types are considered “good” debt (i.e., debt that provides long-term value or an increase in earning potential). Examples of “good” debt include student loans, mortgages, home equity loans and auto loans. This type of debt provides some sort of value to you while also having lower interest rates.

Debt that is considered “bad” debt includes payday loans, credit card debt and cash advances. This type of debt doesn’t provide long-term value and typically comes with high-interest rates.

The reason it’s important to know the type of debt you have is that lenders care about it. If you apply for a business loan, most banks will want to see your personal credit history. Their reasoning is that a business owner who manages her personal finances well will likely manage the business’s finances well. If your personal credit score shows a history of “bad” debt or poor management of debt, many lenders may not want to lend to you.

How are you managing your debt?

Starting a business will add an additional burden on your personal finances. Is repaying your debt already a struggle financially? If it is, think about how business expenses will add to that struggle.

Ask yourself this too: Would you be okay with the prospect of defaulting on your debt or declaring bankruptcy? This could happen if your business fails — and the chances of that are significant. According to data from the Bureau of Labor Statistics, roughly 20 percent of businesses fail within the first year, and 50 percent fail within the first 5 years.

However, you shouldn’t let debt hold you back from starting a business if you are managing it well, meaning that you aren’t struggling to make payments every month and you have a clear timeline of when your debt will be paid off.

Do you have a strong business plan?

If you feel comfortable with your debt situation, the next step is to carefully evaluate your business idea by writing a comprehensive business plan that will show the feasibility (or infeasibility) of your idea. A good business plan will include the following elements:

  • Market research and analysis: This section includes a description of your targeted customer segments (e.g., demographics, size) and of the industry. You should also provide projected marketing data for your products and services and a thorough analysis of your competitors, including their strengths and weaknesses.
  • Financial plan and projections: This includes forecasted income and balance sheets, projected cash flow and expense budgets. You may need to seek the help of a CPA (Certified Public Accountant) to prepare these financial statements.
  • Products and services: This part provides detailed descriptions of all products and services you plan on offering, including advantages they have over the competition. Patent, copyright and trade information is also included in this section.
  • Strategy and implementation: How do you plan on reaching your targeted customer demographic? How will you price your products and services? What is your company’s operating and distribution cycle? How many employees do you need? All of these questions should be addressed in this section.

Writing a business plan is not only critical for getting funding, but it’s also a reality check on your idea. This is because a good business plan will show why your business will succeed (or save you from a potentially bad idea) and will give lenders confidence in lending to you. If you need help, organizations such as SCORE offer free business plan preparation services.

What are your financing options?

Most lenders will require a personal guarantee for the most affordable financing options. A personal guarantee means that you are personally responsible and liable for your business’s debt, meaning even if your business fails, you will have to repay on those business loans. This may be a problem even if you have a good grasp of your personal debt.

If you want to avoid a personal guarantee, you’ll need to look beyond traditional lenders. Many alternative and online lenders will offer loans that require no guarantee (though some, like OnDeck, do require them), and they also have fewer eligibility requirements than banks — a plus if your credit score has taken a hit from your debt. However, the tradeoff is higher average APRs.

Other options for funding include:

  • Crowdfunding: Raising money through Indiegogo or Kickstarter can be great if you’re launching a product with mass appeal, but you’ll have to put in the work to get backers for your project.
  • Business credit cards: These can help build your business’s credit score and are great for short-term working capital, but you need to be careful of falling into a debt cycle.
  • Loans from family and friends: Getting money from family and friends can sound like a great idea, but are you willing to risk your personal relationships if you can’t repay the loan? If you’re confident in your ability to repay, then this may be a sensible option.
  • Government loans and grants: Federal, state and local governments offer a myriad of loans, grants and tax exemptions for small businesses. You can look up grants through the Access Financing tool at business.usa.gov or State Business Incentive Database at the Council of State Governments.

Getting financing to start a new business is a challenge, regardless of whether you have debt or not. Having the right fundamentals in place will make the process easier, but you should still anticipate setback and rejection when seeking funding.

Having personal debt shouldn’t always be a hindrance to starting a business — the key is to be honest about your business idea and ability to manage your debt. Everyone’s situation will be unique, but it is possible to start a successful, thriving business even if you have personal debt.

Rebecca Wessell
Rebecca Wessell
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Rebecca works at ValuePenguin, a personal finance research website, heading up small business content. Prior to joining ValuePenguin, she was a consultant at Ernst & Young, specializing in data governance and financial services. She is a graduate of Syracuse University, where she received a master's in Information Management, and Emory University, where she received a bachelor's degree.
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