Managing Small Business Debt

JohnTaylor January 8, 2014 0

Chances are that if you’re starting a small business, you’re going to need financing to get it off the ground. There a variety of financing sources for small businesses, including credit cards, small business loans, investors, personal loans, etc., but the one unifying factor all of these funding options share is that sooner or later, they must be repaid.

According to the Small Business Administration, traditional lenders such as bank still make up about 65 percent ($694 billion) of the money loaned to small businesses in 2009. Banks and credit unions are attractive lenders because they are likely able to offer you lower interest rates and fewer strings attached than some of the other sources of credit. They also may be able to point you to some government loan and grant opportunities for your business.

Here’s a few tips for understanding and managing your business debt:

Know your loans

There are a variety of financing options available from banks and other lenders. Understanding the different types is key to choosing the option that’s best for you.

Installment loans are traditional loans that give the lender the full amount when the loan is signed and that are paid back in equal monthly, bi-annually or quarterly payments over time. Some installment loans are adjustable rate loans, which means the interest rates can rise or fall over the life of the loan. With interest rates at historic lows, taking out an adjustable rate loan at this time is a terrible idea.

Balloon loans are loans where the borrower pays back only the interest on an installment basis and then pays back the principal on the loan in one large sum at the end of the loan. These loans are most appropriate when the business must wait until a certain date for payment from a client for its goods or services.

Line of credit loans set a maximum amount the borrower can access at any time. The borrower makes monthly payments on the interest and is free to pay back the principal as he or she sees fit. Most line of credit loans are extended for 12 months and must be renewed at the end of the period. Some lenders require that the line of credit loan be repaid for 7-30 days at the end of each 12 month cycle. These loans are best for businesses that may need temporary access to credit for operating expenses.

When taking out a loan, be sure that you understand all of its terms. Ask questions about fees and repayment terms and be sure that you’re aware of any factors such as adjustable rates or late payment penalties that could increase your payments. Also, if you’re able to secure a Small Business Administration loan, do it. SBA loans have a number of advantages, including lack of a prepayment penalty, meaning that if you pay the loan off early, you won’t have to pay an interest penalty.

Borrowing against the equity in your home

Small business entrepreneurs can use their homes as collateral for financing, however, should the business fail this can result in them losing their homes. Typically you can borrow up to 90 percent of the appraised value of your home, less any outstanding mortgages.  Most lenders’ maximum repayment period for these type loans is 20 years.

A good guideline to keep in mind — Typically, your mortgage payment and home insurance shouldn’t eat up more than 28 percent of your income, while these payments and all other debt shouldn’t account for more than 36 percent of your income.

In addition to your home, you may also be able to take out a small business loan on the cash value of your life insurance policy or on your retirement account. Again, be aware of the risk involved in borrowing against these assets.

Credit cards

Many small and home-based businesses start out with credit card financing. Using a credit card for neccessary start-up capital can be a good option for business owners who can’t get loans or credit elsewhere, but because of the high interest rates involved can carry significant risk for the business owner if the venture does not turn out to be profitable.

If you’re planning on starting a business using your credit cards to fund start-up costs, take a minute to peruse the latest credit card offers you’ve received in the mail. Some credit card companies offer 12 months or more of zero interest when you open up a new credit card account. By taking advantage of these offers and using zero interest cards to fund your start-up (and by quickly repaying the amount borrowed) you may actually get more favorable access to credit than you would have had you gotten a traditional loan.

Before using a credit card to fund your start-up, make sure you understand all the terms of the credit card agreement, including interest, borrowing limits, late fees and penalties to avoid making costly errors. Also be sure to avoid penalties by making at least the minimum payment on time each month.

Making payments

After borrowing money to start up or expand your business, be sure to meet your payment schedule. Missing payments can damage your credit, making it harder for you to secure additional financing. It can also result in penalties and possible default on your loan. If you have multiple loans, be sure to pay off the ones with the highest interest rates first, as this will result in you spending less on your debts over time. Also, you may eventually want to consider consolidating your loans, as this can result in lower interest rates and monthly payments.


Refinancing may help you lower your interest rate and/or your monthly payments on your loan. Once your business is up and running you may be able to get a more competitive rate than what you originally received, particularly if you financed your business through unconventional means such as by credit card debt. Shop banks and credit unions to see if you can get a better rate, but be sure to understand all the terms of a refinance agreement, as there may be hidden charges and fees.

Increasing revenue and cutting costs

If the debt situation at your small business is getting uncomfortable, you need to start looking at ways to improve your cash flow. Look at every item on your budget and look for costs that you can cut. Increase your business’

exposure through aggressive, low-cost marketing such as using social networking and e-mail lists to reach customers.

Debt-to-equity ratio

An important figure for small business owners to know when considering their debt is their debt-to-equity ratio. This ratio is calculated by dividing the business’ equity/net worth by its debt/total liabilities. The ratio gives business owners a good idea how much of their business is owned by the owners and how much is owned by its creditors. Established businesses should seek to maintain a 1 to 1 ratio, as letting the ratio drop below this balance will likely make it more difficult to obtain credit if needed.

Reducing personal liability

When seeking financing small business owners may want to consider the benefits of incorporating or forming an LLC, as it can reduce their personal liability should the business founder. Having corporate or LLC status can help business owners avoid losing many of their personal assets should the business go into bankruptcy or become hard-pressed to make debt payments.

By handling your debt effectively, you can make the most out of your borrowing opportunities to start and expand your business, and avoid the pitfalls associated with high debt.

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