As an accounting professional, Ebe Osaigbovo, CPA, knows how important it is for small business owners to borrow carefully. “Always have a plan for the funds. Do not ‘bet the farm’,” warns Osaigbovo, president of Smart with Money CPA.

He also understands how debt can be leveraged strategically. As a CPA, he works with numerous small business clients, including those who aren’t ready to hire a Chief Financial Officer but still need the types of advice a CFO can provide. 

And as an entrepreneur with his own business, he has used small business loans to grow his business. He used a small business loan to invest in marketing, for example. “I had a successful campaign collecting and converting online leads into regular paying clients,” he explains. 

And like many entrepreneurs, he’s seen—and made—mistakes. “I accepted a high interest business loan before and paid more interest than I had to. I learned how to shop around for business lenders through Nav.com and find the best deal,” Osaigbovo says. 

How Can Debt Be Used To Grow a Business?

Debt can continue to entrepreneurial success in a number of ways. Here’s an example:

“Around year three is when entrepreneurs run into cash crunches,” warns Ryan Daniel Moran. In an episode of his Capitalism.com podcast titled Steal My 5-Year Plan to Build and Sell a $10 Million Business, he explains that a business owner bringing in $2 million in sales probably doesn’t think they should have to borrow. 

“This is where entrepreneurs get stuck,” he warns.  

He goes on to explain that a business in this stage of growth, an ecommerce business with successful products will need capital to place larger orders of inventory. Debt financing allows business owners to place these large orders. 

“This freaks a lot of entrepreneurs out, because the idea of having debt to keep the business going is really scary for those who aren’t used to having that much debt,” he warns. 

Moran, has successfully grown and sold his own ecommerce business, and works with many other new businesses in the ecom space. He shares how debt can be leveraged to help a business grow to the next level, by explaining that the discounts achieved from placing very large orders for inventory can be greater than the cost of financing. 

Here are some of the myriad ways debt can be used to help a business grow:

1. Expand your business

Whether it’s a new location, product line, or the opportunity to leverage new technologies (such as AI), you may need to borrow to expand. If you don’t have the cash to do that, you may miss out on the opportunity to launch potentially profitable initiatives. 

2. Invest in equipment and technology 

Better equipment may increase your productivity and profits. A CNBC story about an entrepreneur who makes engraved pet memorials explained how he twice invested in more sophisticated equipment to increase productivity and sales. While he tapped savings, a 0% APR business credit card or other short-term financing could also be used for that type of investment.

3. Inventory purchases

If your business needs inventory, short-term financing can be a lifesaver. It can help you snap up low-cost inventory, stock up for peak sales season, or get lower price points. 

4. Marketing and advertising

Investing in marketing and advertising can significantly increase brand awareness and sales. Debt can finance these campaigns, especially when a business is looking to enter new markets or launch new products.

5. Business acquisition

One way to grow quickly is to acquire another business, whether that’s for the customer base, the physical assets or real estate, or even for intellectual property. Financing may help you move fast on an opportunity. 

6. Improve cash flow

Short-term debt can be used to manage cash flow, ensuring that a business can cover its operational expenses, like payroll and rent, especially during slow periods.

8. Refinancing existing debt 

If your business already has debt, it may make sense to get new financing to refinance it to get a lower interest rate or better terms, and to help you get out of debt faster. 

Why Well Managed Debt Is Important to a Successful Business

Debt can be good or bad, depending on how it’s used in the business.  

Osaigbovo encourages business owners to approach debt carefully and avoid taking on more debt than they can handle. “Business owners should be able to maintain a strong business account balance and manage cash flow so that we can always pay the loan payments on time,” he advises. “It is very easy to accept too much debt and have some unforeseen events, then end up with less funds to repay the loan than initially expected.”

One benefit of managing debt well is that it can help your business establish business credit. On-time payments that are reported to business credit bureaus can help improve your business credit scores. 

Good credit may help your business access better funding at more affordable rates and terms in the future. 

How do you know if debt is affordable? Here are some factors to include in your decision-making process:

Interest rates and repayment terms

How much will it cost in interest and/or fees? How much are the payments, and how often must payments be made? (Some business financing requires daily or weekly payments, for example.) Can you repay the debt early without a prepayment penalty?

Debt service coverage ratio

DSCR is a one of the business metrics that may be used by lenders to gauge whether a business can comfortably cover debt payments. You’ll want to understand it too. Learn how to calculate DSCR here. 

Return on investment (ROI)

Ideally debt should help your business make money. Evaluate the expected return by using borrowed funds. Consider how it fits into your business plan. 

Economic and market conditions

Businesses don’t operate in a vacuum, and you shouldn’t borrow in a vacuum either. While it’s impossible to predict the future, you should have a pulse on the broader economic and business environment, and think through how market changes may affect your business. 

Risk assessment

What happens if you can’t pay? Are you required to sign a personal guarantee? What are the risks if you have trouble paying? Do you have a back up plan?

Need help? Ask your tax professional, financial advisor or business mentor can help you crunch these numbers, provide valuable insights, and help you create a plan for using debt to your advantage. 

What Are Some of the Most Common Misconceptions About Debt?

When it comes to small businesses, there are some common misconceptions about debt that can impact how business owners manage their finances and growth strategies. Here are some common myths:

1. Debt is a sign of financial trouble

While many of us have been taught there is a difference between “good debt” and “bad debt,” there are plenty of business owners who assume a business that needs to borrow is struggling financially. But used well, debt can be used for many of the reasons listed earlier, including expansion, inventory and upgrading equipment or technology.

2. High cost debt is always bad 

Borrowing at low interest rates will make it easier and less expensive to pay back the debt, but there are times when businesses can borrow at a higher cost and still achieve a positive ROI.  

3. It’s best to avoid debt whenever possible

Borrowing strategically can help your business take advantage of opportunities that can lead to greater profitability.

4. Don’t get a loan until you really need one 

Planning for debt can be part of planning to grow your business and improve its financial health in the long term. 

5. Bank loans are best 

While bank loans can offer very attractive terms it can be hard to qualify and the application process can be involved. Alternative lenders, credit unions, and government-backed loans may be more accessible for some entrepreneurs.

Every business needs to evaluate whether borrowing makes sense based on their current financial situation and the opportunities ahead. 

How Can Being In Debt Affect Your Ability To Have a Successful Business?

Entrepreneurship is often stressful and debt can add to that stress. If you’re worried about making payments, you may find yourself making poor decisions. 

But a loan can also cause problems if it makes you feel flush.

“Push yourself and your company into high-gear and do everything in your power (within reason) to make a greater return than your business loan plus interest or overall cost of debt,” Osaigbovo recommends. 

“The last thing a business should do is become less disciplined when the business receives funding. Stick to the plan. No personal purchases or lifestyle inflation. Keep your nose to the grindstone despite your larger business bank account!

What Are Some of the Benefits to Business Debt?

Business debt can help you avoid personal debt, and the risk of commingling personal and business finances.

The Federal Reserve Small Business Credit Survey 2023 Report on Nonemployer Firms found that businesses without employees are more likely to apply for personal loans to fund their business. 

If you do plan to borrow for your business, consider small business loans or financing rather than personal loans. This separates your personal and business finances and credit, since most business loans don’t appear on the owner’s personal credit reports. In addition, some business loans don’t require personal guarantees.

Here’s another reason why a business loan can be beneficial: it can help entrepreneurs avoid giving up equity in their business. A business owner who gets investors, whether through angel investors or venture capital, will give up part of their ownership in their business. Debt does not require giving up equity. 

It can improve cash flow by leaving you with a cash cushion to ensure essential bills like payroll and business taxes get paid on time. 

Utilize Nav’s cash flow tools and to stay on track when you borrow. 

What Is the Difference Between a Loan and a Line of Credit?

A business loan is money you borrow for business needs. It can come in a variety of forms, including term loans which offer a fixed amount of money, and microloans which are small loans often made by non profit lenders fostering economic growth and entrepreneurial activity among borrowers who might have trouble accessing capital.

A small business line of credit is a type of business loan. It offers an amount of money you borrow against as needed. Pay it back and borrow again if needed. Many businesses get lines of credit so they can borrow when cash flow is uneven. 

Don’t overlook the line of credit that underlies most business credit cards. These are especially helpful to those who are newly self-employed. Startups often find it challenging to get small business financing because they don’t have a track record in business but most business credit cards don’t require a specific time in business, and will accept income from all sources, including household income. 

Remember the Fed Survey we mentioned earlier? It also found that business start-ups without employees are more likely than older (more established) nonemployers to apply for a business loan, while applications for loans made or guaranteed by the Small Business Administration were more common among more established businesses without employees.  

Startup loans can be challenging to get. SBA loans offer attractive terms if your business qualifies, but expect an often lengthy application process. (Plan ahead!)

What Are the 3 Common Mistakes Entrepreneurs Make When Leveraging Debt?

There are three major mistakes that make when borrowing for their business:

1. Assuming you won’t need it

A business that can grow organically from cash flow is a great goal, but business owners often find that no business has the perfect business model, and things rarely go exactly as planned. (The challenging business environment of recent years was something they didn’t teach in business school.) Familiarize yourself with small business financing options so you can make good decisions when you need it. 

2. Waiting until there’s a cash crunch

Understanding your qualifications, and shopping for financing periodically will make it easier to find the right financing when you need it. At a minimum, consider a line of credit so you’ll have access to cash flow if something suddenly comes up—whether that’s a problem or an opportunity. 

3. Taking the financing that’s best marketed, not best for you

As soon as you register a new business you’ll likely start getting offers for business services, and business financing. There’s nothing wrong with considering those offers, but you’ll also want to look proactively to find the right provider and the right financing for your business. 

*Note: Ebe Osaigbovo shared his advice and experience with Nav without compensation.