Is right now a good time for small businesses to take on debt?

Small businesses must make sure they've got the cash they need to fund their recovery as we come out of lockdown.

Is right now a good time for small businesses to take on debt?

Small businesses must make sure they’ve got the cash they need to fund their recovery as we come out of lockdown.

Last year small businesses took on £104 billion of debt through government-backed loan schemes. As the economy recovers, plenty more businesses will look to grow and will be considering borrowing more money to do so. Although the fee and interest-free schemes are no longer open to applications, there are still strong reasons to explore debt options.

For businesses, poor cash flow is a huge threat to survival. Around 80%-90% of small businesses that fail put it down to their working capital being too weak. Strengthening yours is the key to success, especially after such a tumultuous period. 

Growth isn’t cheap, so if you want to grow then you’ll need to find a way to fund it. The simplest route is often by taking on some kind of debt facility. A lot of entrepreneurs are nervous about additional debt because we tend to see it as a negative in our personal finances. But debt can be a cost-effective way of boosting your profits in the long run. Loans, invoice finance or another cash facility are a good idea for even the most profitable blue chip companies.

You can of course raise funds through investors, but that comes with a caveat: handing over equity in your business. What’s more, they’ll want a return on their investment, which is often higher than the interest rate on a loan. And usually it takes much longer to find and convince investors than securing funding through a commercial lender does.

Crucially, investors also have a much longer term stake in your business, and therefore profits. Debt, on the other hand, is fixed-term. Once you’ve paid it off, your interest payments are over. Generally debt helps a business keep hold of its profits as they don’t go to investors, and the interest payments can be deducted from your tax bill.

If you’re unsure what the future will bring, it’s understandable you might be afraid of taking on more debt than you can afford. However, if you’re using it to improve or upgrade your business then it is usually a good decision (provided you can afford it). Ultimately, having access to cash means you can strengthen your position because it facilitates your own investment in new software or machinery. In the medium or long-term it can improve your profits.

If the debt you’re using will contribute to growth and profitability it’s probably a good idea, as long as you can use your profits to pay the interest. Take a look at your current demand and profitability. Forecast the kind of growth you could expect with a little more investment. Make sure you really understand if you can manage future interest payments. 

Before you take out a loan, consider how risky you look to lenders if you take on too much debt. While having a couple of facilities in place can help fund growth, having high interest payments makes you riskier to a lender. In turn, that will be reflected in the interest rates they offer you, so always be aware.

The government’s successor to the Coronavirus Business Interruption Loan Scheme, the Recovery Loan Scheme (RLS), offers viable businesses better borrowing opportunities. It has an 80% government guarantee to give lenders an incentive to offer funding. They’re encouraged to lend to businesses they might not normally lend to, or to give more favourable interest rates. 

Even if you’re just using a facility to cover overheads and running costs, you’ll have more time to focus on what really matters: your business. Having enough cash in the tank to see you through recovery will be key to emerging from the pandemic stronger. An RLS facility can be used for any legitimate business purpose to help recovery. 

Debt is like water. Use it well and your company will stay hydrated and can grow. Take on too much and it could submerge your business.

Anil Stocker
Anil Stocker

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