When entrepreneurs are thinking about starting their own business, one decision that weighs heavily is whether to go into debt.
As seen in the recent post, Small Business Funding By the Numbers: What Every Entrepreneur Should Know, there are plenty of financing options available to small business owners.
However, not all types of financing, and debt, are the same. Should you go into debt to start a business? Consider the pros and cons.
According to the National Small Business Association, about 73 percent of small businesses used financing within the previous year. The vast majority of those relied on personal savings (57 percent) with personal and business credit cards (10 percent) and bank loans (8 percent) far behind.
Using debt is not uncommon. The U.S. Small Business Administration notes that 63 percent of small businesses have some debt. Smaller and younger companies tend to carry more debt.
Advantages and Disadvantages
The advantages of using debt financing include:
- Access to funds. For entrepreneurs without the personal savings to start a business, debt is often the only viable option.
- Low interest rates. For those businesses that qualify for a loan, interest rates are still relatively low, meaning it is not going to cost a lot in interest payments to borrow.
- Different options available. When used for large investments, loans may qualify for longer repayment terms.
However, there are some downsides to carrying debt, including:
- Unpredictable economy. With recent stock market volatility, interest rates may again be on the rise, meaning entrepreneurs will be taking on more debt that they would have just a few months ago.
- Credit score. More debt, especially if it goes unpaid, may lead to lower credit scores, making it more difficult to borrow, both professionally and personally, down the road.
Different Types of Debt
Not all types of debt are created equally. If you choose to go into debt, you should know the different types and features.
- Bank debt is the most common and requires entrepreneurs to apply for loans that will have different repayment plans and interest rates. Using a financial institution for your financing allows you to develop a relationship with the lender that can serve you well in the future.
- Credit cards are one way to finance a business, but usually carry much higher interest rates than traditional financing. The compounding impact of this debt can cause companies and individuals to quickly acquire large debt burdens.
- Home equity is a way to leverage the value of your home to secure a loan. However, the property becomes collateral that is exposed if you do not repay your loans.
Benetrends has developed an innovative approach to small business funding that does not require entrepreneurs to take on more debt. For decades, Benetrends has helped business owners start and grow their businesses by using existing 401(k) and IRA accounts.
Benetrends helps companies establish their businesses as a C corporation and transfer existing retirement funds to the new business entity. You can open the doors to your own business, tax-deferred and penalty-free! To learn more about our 401(k) business funding option, download Innovative Funding Strategies For Entrepreneurs today.