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Be Smart About Business Debt
Amassing big debt in your business can really hurt you.
by H.M. Cauley
September 1, 2005
A
s the adage says, sometimes you have to spend money to make money. But just as a shopping
spree can break a budget, amassing debt can be a detriment to a business's success.
"If
you can avoid going into debt while starting up a business, that's always a good place to start,"
says Mary Ellen Garrett, a 23-year veteran of and first vice president of investments at Merrill
Lynch. Investment experts suggest that many entrepreneurs enlist the aid of friends and family to
get a business off the ground. It's one of the best ways to avoid starting off with a heavy debt
load.
"In today's market, it's very, very difficult for a bank to get comfortable with a company
that has no hard assets," says Andrea Comeau-Shirley, founder of Namaste Consulting, a
Mableton-based firm that works with many start-ups. "Even the Small Business Administration has
turned over so much of its loan approval to the banks that their decisions are flavored by them.
With friends and family funding, you can raise money in $5,000 or $10,000 blocks to get going
pretty easily."
Another way to keep debt down is to borrow against a nest egg. At Merrill Lynch, Garrett is
working with more entrepreneurs who are at a stage of life that they have accumulated assets that
can work for them.
"I have several clients who are retiring early, at around 50, and they've decided to start a
company," she explains. "They don't have a track record to show to a bank, but they can take some
of their assets and instead of selling them, borrow from them. It's a very inexpensive way to get
started and it's very manageable."
Well-Managed Debt is Good
Boutique owner Julie Routenberg's experience in setting up a designer clothing business
meant going beyond her family and friends network.
"In the perfect world, it would be wonderful if everyone could fund their own business, but
that's not always possible," she says. "I think some debt is necessary and if you do it properly
and you're careful, it works only to your benefit."
Routenberg launched Potpourri in Buckhead almost 30 years ago. A second store in Sandy
Springs soon followed as the demand for high-end collections and personal service grew.
"When growth starts, that's when you need loans," says Routenberg. "About three years after
we got going, we started borrowing, first with a Small Business Administration loan through our
bank that provided working capital to buy more inventory. Then we went through a series of cyclical
borrowing: During a fall or spring season, we'd go for another small- or short-term loan. But when
we decided to open the second store, we were able to borrow bigger bucks because our credit was
established."
Today, Routenberg has al ine of credit that allows her to borrow when needed. "The key thing
is not to let the debt-to-worth ratio get out of sync," she says. "We have worked hard so that
doesn't happen. It's very easy to get into debt."
Though experts caution about carrying too much debt, being able to demonstrate your ability
to handle and repay loans is a plus when it comes time to meet with the bankers.
"I advise most companies to wait a few years before borrowing because banks like to see a
three-year history," says Comeau-Shirley. "It doesn't even have to be positive cash flow, but you
have to show growth in revenues and a business plan that shows how you can attain growth in market
share. That requires a realistic plan -something many entrepreneurs don't have."
Garrett agrees that most lenders are looking for positive gains.
"And a lot of that depends on the size of the company and how quickly it is growing," she
says. "For instance, I have one client who was steadily breaking even. Then all of a sudden,
business went through the roof when a product took off nationally. They had to hire more people and
bring in more equipment. Because they could show a growth trend, financial institutions went from
not wanting to lend them a penny to giving them half a million dollars. And next year, they'll
probably borrow more than that."
Cash Is a Good Thing
Once a small business is underway, there are a variety of ways to keep the cash flow coming
without having to takeout loans.
"One of the most common is that the owners re-invest their salaries into the business for
some time," says Comeau-Shirley. "Of course, that's code for not taking any money out. But you need
to get to the point where there's an inflow of cash that you can show to a lender when the time
comes."
Today's technology plays a major role in helping small businesses cut expenses.
"Setting up an office has become much more affordable as technology prices drop," says
Comeau-Shirley. "Even setting up your own Web site is fairly simple. There is software now that
allows you to get your name out there, send out fliers and add that air of credibility that a Web
address gives you, without having to hire someone for $30,000 to come up with a design."
Will having some debt be a deterrent to a lender giving you more? Not necessarily, says
Comeau-Shirley. "Some amount of debt is fine. If a company comes in with debt, but the lender has
faith in the company, they'll have faith that the debt will be taken care of."
"Some debt is not a bad thing," agrees Garrett. "But you have to manage it, just as you do
your assets. In a way, a little debt is almost a kicker to keep things real."
The Right Write-Off
One of the lures of owning a business is the idea of taking write-offs for expenses and
losses. But before you start thinking that you'll never pay taxes again, talk to an expert.
"Unfortunately with tax law, there's always a caveat," says Kathie Gottlieb, a partner with
Donner, Weiser & Associates, who works largely with small and new businesses. "Everything has a
'but' on it. It's always better to get your question about a write-off answered first than to try
to undo something later."
One of the most common questions Gottlieb fields is about home offices. "You can't have
access to or use of another office," says Gottlieb. "If you don't, then you can also consider your
expenses - from mortgage to pest control - and take a percentage deduction based on your square
footage."
The "but" is that the office must be used exclusively for business; it can't be a corner of
the kitchen.
Another frequently asked question has to do with vehicle purchases. "Generally, an auto has
limits on how much you can write off each year," says Gottlieb. "But a vehicle of more than 6,000
pounds that was put in service before October 2004 could be written off 100 percent. That meant a
lot of people were out buying Hummers and SUVs. That amount has now dropped so the write-off limit
is $25,000, which is still good."
But whether you're treating a client to dinner at a five-star restaurant, buying a fancy
laptop or eyeing a new car, one rule always applies to write-offs, Gottlieb cautions. "Never let
the tax benefits outweigh common sense."
