Choosing the Small Business Debt Product For You | Tory Burch Foundation

Debt has a bad reputation. It’s generally considered preferable not to owe anyone anything. But when it comes to business, healthy debt helps you grow and innovation. Dorothy Kolb, fractional CFO and founder of DK East Associates, joined our webinar series to demystify small business debt and explain which debt products to avoid, if possible. She shared insights on what kind of debt can help your business, what kind of debt to avoid, and how to determine if it’s the right time for your company to take the leap. 

IS NOW THE TIME TO TAKE ON DEBT?

While loans and credit cards can be helpful when your business is struggling, times of strife are not when you should be shopping for debt products, Kolb explained. You should only take on debt if you’re confident you can pay it back and that you can pay it back on time. Essentially, you want to find a sweet spot: a time when the money would be helpful, but not a lifeline. Build business credit when things are going well by paying down debts in a timely manner; payment history communicates to creditors and potential investors that you’re trustworthy. Kolb recommended making the potential loan repayment a line item when doing projections of how much cash you anticipate earning and spending to estimate how that debt will fit into your operation. Online loan interest rate calculators can also be useful to assess what you’ll be able to afford based on your unique business factors and situation.

If you decide that now is the right time for your company, you next need to consider how quickly you need the funding. Is there a retail space you want to snatch up? Do you have your eyes on a machine that would streamline your production process? Some loans can take months before you receive funds. That doesn’t mean you should run to lenders who promise quick payments with lots of hidden strings (more on that later), but consider your options carefully. 

The ultimate goal is to build an impressive business credit score. Much like your personal credit score, on-time payments, how long you’ve been accruing credit, and how much credit you have available to you are all factors that can raise or lower your score. Apply for an Employer Identification Number (EIN) with a credit bureau such as Dun & Bradstreet, FICO Small Business, or Experian Intelliscore, and use that EIN to apply for a business credit card. Kolb recommended checking your business credit score at least once per year, if not quarterly. 

DEBT PRODUCTS TO CONSIDER

Small Business Loans

When applying for a small business loan, you should use a bank and representative that you already have a relationship with, if possible. You’ll get a more personalized experience and they may be more inclined to want to help your business grow. 

If your business is very new, it’s possible that you’ll be asked to provide a personal guarantee when applying for a loan. This means you’ll have to put forth collateral, such as your home, as a way to promise that if for any reason your business can’t fulfill repayment, lenders will still get their money. In this case, you are putting your personal credit score at risk, so it’s even more important to manage your business’ debt well. Even with collateral, a bank may reject a business that has been in operation for less than two or three years.

SBA Loans 

Low interest rates and payback timelines of up to 30 years make Small Business Administration (SBA) loans a good option for most borrowers, but Kolb warns that they aren’t ideal if you need funding quickly. The approval process involves lots of paperwork, and several months could pass before you see any money. It’s also worth noting that collateral is required for loans greater than $250,000. The SBA’s 7(a) loan program also helps business owners with “acquiring, refinancing, or improving real estate and buildings”. 

Microloans

Microloans from community development financial institutions, or CDFIs, are great if you’re borrowing under $50,000. They’re also very small business-focused, with alternative financing options and the potential for low interest, if not interest free, repayment. Start your search with the U.S. Department of the Treasury’s database of CDFIs. 

CDFIs can also be helpful if your business is considered too high risk for other loan options. But Kolb advised that if you’re getting feedback that your business is high risk, try to understand why. Is it just that you work in a risky industry, or is there something unstable within your operation? Try to correct or lower that risk, if you can. 

Founders can also turn to nonprofit microlenders. Kolb specifically highlighted Kiva, a global nonprofit that provides crowdfunded, interest-free loans. 

Lines of Credit

Apply for lines of credit, like credit cards, when your business is doing well and the net profit is high to increase the likelihood of being given a high credit limit. You want to acquire a line of credit before you need it, and use the money like an emergency fund. Take what you need when you need it, but pay it back right away. You should also consider the perks offered when considering a business credit card. Many cards offer cash back, points toward discounted travel, no annual fees, etc. Choose the card that most aligns with your needs. 

Commercial Real Estate Loans

As the name indicates, these loans are for purchasing, refinancing or renovating the physical location of your business. Banks, online lenders like iBusiness Funding and credit unions provide these loans. 

Equipment or Inventory Financing

If you need a major piece of machinery for your business, you may be able to get financing through the seller. The financing is usually available as a short-term loan or revolving line of credit.

GETTING YOUR PAPERWORK IN ORDER.

To apply for debt financing, you will need:

• Business plan: It should detail what your business does, who the stakeholders are and what sets you apart in the market
• Business license: If you’re working out of your home, be sure you’re licensed in your locality.
• Financial statements: Generally, that includes your company’s profit and loss statement, balance sheet, cash flow statement as well as your personal financial statements.  
• Three years of projections for your business’ financial growth. Don’t be too concerned with being “right.” Do your best. “Projections are 100% inherently wrong,” Kolb said. “If they were right, there’d be a ton of us sitting in Vegas all the time doing financial projections.”
• Personal and business tax returns 
• Articles of incorporation or articles of organization 
• Leases for any occupied spaces. 

PREDATORY LENDERS: DEBT PRODUCTS TO AVOID.

There are many ways in which debt can help your small business, but it’s important to be cautious of predatory lenders and scams that want to take advantage of your vulnerability. Women and people of color are the most common victims of these schemes. Classic markers for predatory lending include high interest rates, excessive fees, and unrealistic terms and conditions. 

Invoice factoring and invoice financing appear helpful if you need money, but your clients are taking longer than expected to fulfill their invoices. Invoice factoring, or selling an invoice to a third party lender, can be bad because that company keeps a share of the repayment. This means you’ll never be made whole for the original amount you were owed. This can also be an unfavorable option because your clients are aware that they now have to complete their invoice with this third party instead of you. With invoice financing, a third party lender will give you money for outstanding invoices, but they take their repayment (plus interest) directly from your revenue instead of the client. 

Payback for revenue based loans is calculated based on your estimation of how much revenue you think you’ll acquire within a set period of time. Shopify Capital loans are an example. These lenders take their money directly from your gross revenue and on their own terms/schedule, regardless of your expenses or other financial obligations. These can be tricky because if you haven’t budgeted properly, you could be left without enough capital to run your day-to-day operations. 

Short-term or weekly loans offer you money quickly with low interest rates at the start, but that rate can skyrocket as it compounds over time. 

In general, it’s good practice to have a lawyer or CPA read over the fine print in loan agreements to ensure you’re not signing up for variable interest rates or hidden origination fees. Don’t be influenced to agree to anything before you’ve done your due diligence. 

YOU’VE HIT A ROUGH PATCH AND PAYMENTS ARE DUE. 

Sometimes we make mistakes or circumstances outside of our control leave us in precarious financial situations. No need to panic. There are strategies you can utilize to pay down your debt and protect your credit score. 

If you have a loan through a bank, try to renegotiate the terms. This is where working with a bank or representative that you have a rapport with can be useful. Have a conversation with them about the state of your finances and what you can reasonably afford to repay. In terms of credit cards, at least pay the minimum. And don’t be embarrassed. The banks want you to be successful, and they’ll work with you. 

You should also take a look at where you can course correct in-house. Evaluate repayment terms with your own customers and circle back with them to collect on debts they may owe you. 

Considering what expenses you can reduce, such as unnecessary subscriptions or unused software can also free up funds. 

Kolb recommended paying off lower debt balances first and then using that payment amount against the next lowest balance, as opposed to chipping away at larger balances. You’ll gain a sense of accomplishment and organization because then you know which cards have been cleared. But it’s important not to start reusing a card that you’ve paid off. Don’t close out the account, but stay focused on repayment first. 

Debt forgiveness plans can also be a good tool when you’re struggling to pull your business out of a hole. They can temporarily affect your business’ credit score, but you can rebuild over time. Bankruptcy is also an option, but take a close look at how intermingled your personal credit and business credit may be. If you’ve been vigilant about keeping your personal and business separate, then feel free to move forward, but any overlap could drag down your personal credit score as well. “If you can work through some kind of a renegotiation, consolidation or debt forgiveness and get yourself out [of debt] without filing bankruptcy, that’s great,” said Kolb.