To borrow or not to borrow, that is the question.
For many small business owners choosing to borrow can feel a lot like getting a vaccination. You don’t really want to do it, and there is a little bit of short term pain involved, but you know ultimately your health will be better off in the long run.
According to the Australian Bureau of Statistics the commercial lending market in Australia is a $40 billion-dollar industry, more than double the amount borrowed in the higher profile home mortgage market. When compared to sourcing equity as a funding alternative, borrowing offers several advantages to a small business owner that an equity partner can’t provide:
1. Maintaining control
You may need to provide some form of security and furnish your financials on a regular basis, but ultimately borrowing still allows you to call the shots. Having an investor seldom comes without their input and desire to be involved in how their money is spent. Borrowing keeps the relationship at arms-length allowing you to get on with running your business yourself.
2. Maximising profits
Keith’s café would benefit from a $100,000 renovation. Keith is faced with taking on an equity partner for 25% share or borrowing the money to complete the fit-out. Keith’s business is profitable and he predicts the renovation will add an additional $30,000 to his bottom line thanks to increased seating space. He bites the bullet and takes the loan option. Within 4 years the increased income has repaid the loan and Keith can enjoy his additional profit himself without paying out 25% of it each year to a new partner. His decision adds thousands of dollars to his bottom line each year.
3. Early repayment
Taking in an equity partner is a long-term financing decision. You can’t repay them when you feel like it. Jane made the decision to take an equity partner when she moved her restaurant to a new location just two years ago. Her turnover has doubled in the higher profile area but she has some regrets. Borrowing for the move would have seen her completing the repayments within the first twelve months. She now pays out 20% of her profits each month to the investor – money she doesn’t get back.
Gavin runs an online ecommerce store importing pet products from Taiwan. Last month was his most profitable month since starting two years ago, thanks to short term borrowing. Gavin was contacted by his supplier about a cancelled order they had planned to sell to the US. The supplier was willing to provide the product to Gavin at 35% off the normal wholesale price. Thanks to some short-term funding Gavin was able to bank-role a buy up of all the stock and priced it through at a healthy discount on his site while still maintaining a better than average profit. He had the loan repaid in less than 90 days and he is looking for the next opportunity to repeat the process.
Borrowing gives the ability to make decisions quickly and obtain funding approval far faster than finding an equity partner. Tara’s media company had the chance to secure a new client which would double the size of her business overnight. To take the task on however she needed to expand her office and hire three new web designers. Thanks to funding approval in just 48 hours she was able to commit to the client, confident that she had the finance to secure the resources she needed to do the job.
There is no doubt a loan comes with a cost, but where that cost is offset by the profits that the funding can achieve it makes sense to borrow. There are few investments that have the ability to offer a significant return like business profits can, and the cost of waiting when these opportunities come along can be the difference between following your current path and taking your business to a whole new level.