Debt is good

One of the strangest thing that I’ve learnt as a small business owner of a board game store is that debt – owing people money – is good.  This is particularly interesting for me since I hate debt in my personal life, but for a corporation, perversely it can be very good.

There is two types of debt available for the most part, and how they can be good for a business is what I’m going to discuss.

Short term debt

Most commonly, short term debt comes from terms provided by your suppliers.  This could be anything from advertising agencies or websites to distributors.  The longer your terms, the better as you are able to (hopefully) recoup the expense via revenue generated before you have to pay out.

So if you consider it in terms of game distributors, a 30 day term gives you 30 days to sell all those games you purchased and then pay back your distributor.  Simplified greatly, if you receive a 100% margin on your board games, you only need to sell half of your order in 30 days to actually have the revenue to pay your distributor.

Oh, another form of short term debt is the Line of Credit or overdraft facility; a very useful feature to help deal with short-term cash flow issues.  If you recall my discussion about cashflow earlier, you can see how having a line of credit to deal with bumpy patches will come in very handy.

Long term debt

Long term debt generally comes in two forms for small business owners – shareholder loans (i.e. your personal loan to the company) and bank loans.  Now, your shareholder loan is rather obvious but something worth noting is that in the event of a bankruptcy, you are more likely to receive a portion of the assets remaining as payment for your loan first.  If you have shares, the remaining cash is paid out to shareholders (if any).  So it’s better to have a shareholder loan rather than actual shares of the same amount for this reason.  There are also good tax considerations that I’ll allow those with the expertise to mention.

Instead, I’ll focus on bank loans.  If you are a limited liability corporation, unless you guarantee the loan yourself, if you do default, the bank can only go after the assets of the company.  That provides you with a degree of personal safety when launching the corporation.

Also, loans can be used to do a number of things including consolidating short-term debt (e.g. if you are running balances on your credit cards) to decrease your overall debt servicing costs.

Lastly, loans can you give the capital to grow much faster than you would be able to by organic methods.  As an example, if you could use that money when you first launched to do an effective advertising blitz, you might be able to generate revenue faster.  Or you could use the loans to stock even more product, decreasing the number of ‘re-order points’ you have and providing even more choice for customers – ensuring you have something for everyone who comes in.

The Perversity of Business

Now here’s the really funny part of business. The time when you most need debt is during periods of change for the company (i.e. at launch or when you are growing to the next stage of your business).  However, these are the times when you are least likely to get loans. Generally, the more change there is, the more risk, thus the lower chance of being approved.

It’s kind of amusing really, but that’s life for you. Or business at least.