As a startup business you pull resources together from wherever you can. You use your own savings, borrow from family and friends, take on investors, and secure business loans. With luck the income from your business can repay those initial costs quickly, but not all businesses can follow this model. Sometimes the only way a business can grow is by taking on debt. Before you accept the terms of any loan(s) you may take out, make sure you’re familiar with the following common causes of business debt and how to avoid them.
Business loans
Bank term loans can be difficult to obtain for a business and often come with a high interest rate. If you’re not careful, you can cripple your company before it gets off the ground.
How to avoid debt: Bootstrap as much of the company as you can. Use personal savings if you are able and reinvest profits in the business to grow.
Inventory
Managing inventory is a complicated venture. In order to keep prices competitive, you need to order inventory in bulk. But bulk ordering can backfire if product packaging changes, or if it has a short shelf life. Ordering in higher quantities may bring down your unit cost, but if you end up with inventory you can’t sell, that cost reduction is erased.
How to avoid debt: Make sure your sales projections match up to your inventory ordering. Realistic projections will tell you if a volume discount is worth the investment.
Equipment
Investing in equipment can revolutionize your business. Automation can improve workflow, increase output, and improve safety and cut down on how many employees you have to hire.
How to avoid debt: Before you make an investment in equipment, you have to calculate your return and how quickly you will begin to benefit. If a machine is going to take ten years to pay off, will the cost savings cover the investment, repair, maintenance, and eventual replacement of the machine? Don’t go into debt over fancy new toys if the numbers don’t support it.
Personnel
It can be difficult to determine if hiring another employee will translate to increased revenue. You may create a sales position and target certain verticals in an area the market simply doesn’t support. New administrative positions may not produce greater efficiencies if the person hired doesn’t perform. Today’s marketing departments need to have an excellent understanding of social media and how to leverage sponsored ads. Bookkeepers may streamline your finances but there may not be enough work to justify a full time accountant.
How to avoid debt: Thoroughly vet your job candidates. Check their references and run background checks. Test the market by moving current high-performing employees around. Outsource sales lead generation to optimize your prospecting. Outsource your bookkeeping and accounting so you only have to pay for the hours you need.
Expansion
There are a lot of costs associated with expanding your business. If you’re moving to a larger location you’ll have relocation costs along with increased rent and utilities. Opening a second location is a large investment of people preparing to open before any revenue can be generated. Having to close a second location can put a negative light on your brand and make your business suffer as a whole.
How to avoid debt: Consider franchising your business so the burden of success falls on the individual owners and you will continue to make income on the new locations.
Customer default
If you have an ongoing relationship with retailers and customers, it is likely they are on some kind of payment schedule. Customers sometimes default on payments resulting in “lost” inventory. Recouping those losses through debt collection is unlikely to yield the entire debt and the tax write off for the loss is small comfort.
How to avoid debt: Have a lawyer review your contracts to make them ironclad. Require large deposits for products and services. Be wary of unusual orders or orders that seem too good to be true.
