Debt. That one word may cause more gastric upheaval than any other word in the English language. It can be simultaneously viewed as a positive building tool and as an evil, cash-sucking vacuum. Managed properly, debt can allow a business to grow and develop in ways otherwise not possible, and the inverse is just as true. Poorly managed debt or poorly planned debt can be the downfall of an otherwise viable business.
Debt is a business tool, but it is a tool one does not buy once and use over and over. Unlike a hammer, debt is a tool that must be purchased every time it is used, and the price of that tool can vary widely and even change during the course of its use. Savior or destroyer, debt is part of most businesses, and our grasp of how it works determines its label as a tool that helps or harms.
The basics of debt are simple. You borrow money from somewhere else, invest that money in your business and/or inventory and then pay back a larger amount at a later date. It can be hundreds of thousands of dollars borrowed from a bank for enlarging your building and buying new inventory, or it can be a few hundred dollars taken out of your retirement account to cover a utility bill. The bank will have a long list of fees and interest involved with loaning you the money, and borrowing from your retirement account costs you the potential for growth. Either way, you pay.
Anthony Mantova of Mantova’s Two Street Music offers this: “Use smart debt for big moves that make a lot of sense. Debt is your friend, as long as it will flip! If you don’t know what sells, don’t get too crazy with debt.”
Daniel Elliott of The Strum Shop has just the opposite approach, which is: “Stay out of debt. Don’t spend money until it’s actually in the bank. Pay in advance for your inventory purchases. Make sure you have reserve cash for the lean times. And did I mention stay out of debt?”
He added, “I disagree with Anthony. Debt is never your friend. The only time I would consider debt at this stage is maybe to buy a building.”
Two successful store owners, but with opposing views on the use of debt. Confused yet?
Kevin Walters at Central Penn Music has a more situational approach, where he considers debt to be useful, as long as it serves his purpose. “Debt is something that can be utilized to your advantage, but all too often ends up being the thing that keeps you from sleeping at night. A credit line that you can draw from in the slow times can help your sanity and allow you to purchase what you need to have for your customers when you need it. You have to have the discipline to pay off the credit line every year. (Having the) least amount of debt you can function with is generally better.” Kevin used a phrase that I think is worth repeating. “You have to have the discipline to pay off the credit line.”
For new store owners, the amount of discipline it takes to run a store may be daunting, but for all store owners, the discipline to allocate money responsibly can sometimes be a challenge. This is where having an accountant or a reliable third party to handle your spending in a logical, unemotional way can help you avoid sleepless nights down the road.
Scott Gilreath of Musical Depot offers a pearl of debt wisdom with one sentence: “… My advice would be to avoid going in debt unless there is no other possible way to get through it, and if you do, before you sign the dotted line, make sure you have a plan with a timeline to pay that debt off as quickly as possible.”
Taking on debt can be beneficial to your business, as long as you know how it will be paid back and how long it will take. Remember that money used to retire debt is money not being used for other needs. Borrowing $50,000 on a 90-day note to buy school products when you’ve got a profitable school purchase order sitting on your desk is a low-risk, reasonable use of debt. You know how much you need, you know how much the payoff is and you know when and how the note will be retired. That debt purchase is a no-brainer. Get the loan, get paid, keep the difference.
Borrowing a similar amount to buy a truckload of pointy-headstock Where-istani guitars that your rep convinced you to buy because they will be the next big thing may be a less-than-stellar debt move.
So, debt can be a useful tool, as long as it is managed and planned responsibly.
Two more things I’d like to pitch out there about debt: First, debt is a commercial product. Buying debt is not much different from buying tires or a refrigerator. Before you sign the dotted line, visit multiple lenders, and get a feel for who you can work with easily. The lender’s approachability is important, because your lender will be intimately involved with your business life, and that involvement is a lot easier when you are on an easy, first-name basis with your lender.
Second, not all debt is created equal. Just like buying tires, all debt looks the same at 10 feet, but up close, debt offerings can be very different. Interest rates will vary, grace periods will vary and other fees will vary. Make sure you fully understand what you are committing to before you sign on the dotted line. Also, if you don’t like the interest rates or the terms, negotiate. In a loan, the lender is renting you money, and how much you pay for the rent is always open to discussion. If the lender isn’t open to discussing interest rates or terms, thank them for their time and go see a different lender.
The interest rate the bank charges is a reflection of how much risk they think they are taking in making the loan, and how much un-loaned cash they are sitting on at the moment. If you have a good plan for using the money and paying it back, and the lender understands your plan, that understanding may reflect itself in a more favorable rate. If the bank hasn’t met their lending goals for the month, they may offer a lower rate to help get some of their cash working for them.
It also never hurts to be on good terms with more than one bank. If you belong to Rotary, Civitan or the local chamber of commerce, you already know more than one banker. Even if you don’t need a loan, drop by and have a cup of coffee with two or three of them. They’ll ask how business is doing, and that creates the opportunity for a more involved relationship at a later time. Remember, even the friendliest banker is constantly sizing you up as a potential buyer for his products. You may never need that loan, but if and when you do, that’s the wrong time to start developing your lender relationship. Let some lenders get to know you when you don’t need their products, and it may make the money-rental process, should you need it, a lot more pleasant.