The Downside: Starting your Business with Debt

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Companies often come to us looking to raise debt for their start-up. However, they fail to properly quantify the magnitude of starting a company with debt. We attempt to put things into perspective rather than explain how the debt amortization schedule impacts the cash flows. Think about how difficult it is to swim in the middle of the ocean. The current is making large waves, there are omnivorous amphibians surrounding you. That is what your business is when you are first starting out. Taking on debt is like adding a dumbbell to your ankle as you now try to stay afloat with legal obligations. It makes you now pressed for time and forces you to find new ways of making revenue in an effort to pay back the loan amount.

 

Even companies that are in sectors with his success rates such as the services or real estate industry may be impacted by this risk at first. Rather than going directly to a bank without operating history or business credit, you may find a lower cost of capital in another source. It may be embarrassing to request resources from your network, but the result may be the salvation of your company from a snowball of debt obligations.

Most recently, the federal government announced its decision to slowly raise interest rates on debt. This means that companies will now have to pay higher interest rates on their debt and makes equity or alternative financing an increasingly attractive option. Even with programs like the subsidized SBA 7(a), interest rates are increasing and lenders have become more selective since the financial crisis.

By making these criticism about taking on debt to start a company, we do not mean to say that it should universally be shunned. There are many instances where financing with both debt and equity is an attractive option. This allows your company to acquire more capital while managing the cost through difference financing channels.

Companies that are more mature and have an operating history can more effectively manage debt on their financial statements. Their debt to equity structure is different start-ups because they have the ability to consistently generate free cash flow that can pay the debt while investing it at a profit. Issuing debt to purchase a new production facility in order to fulfill demand would have a very low risk associated with it, thus bringing a lower interest rate and higher return. For new companies, this is almost certainly not the case. Unless the company has a production contract, there is a very high risk of acquiring new customers and providing a product/service that meets their demands.

Our business plan consultants work with entrepreneurs to carefully develop an approach to financing that works best for your company. If you are a new technology startup that needs a strategic investor to assist with a product launch, just need to issue debt in order to acquire a new asset for your production operation, we can help you to determine the proper financing allocation.

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