Debt and Business (Good Debt, Bad Debt and Everything In Between)

Victoria Marumo

Hi there and welcome back! Trust me to remind all first-time readers to check out previous articles to better understand the chapter we are on now. Today we are tackling debt.

CAUTION: Borrowing more than you can afford to pay back is a very dangerous game! Debt may be difficult to obtain in the early stages of a business because you don’t yet have a clear track record.

Anyway, there is good debt and bad debt and if you are wondering how on earth debt can ever be good, then I have just the answers you are looking for. But first, definitions; Debt is an amount of money borrowed by one party from another. A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest. In business, debt is an amount owed for funds borrowed. The lender agrees to lend funds to the borrower upon a promise by the borrower to pay interest on the debt, usually with the interest to be paid at regular intervals. A person or business acquires debt in order to use the funds for operating needs or capital purchases.

Equity financing, involves the process of selling a portion of your firm to investors which is external equity financing and internal equity financing occurs when the owner funds the firm from personal funds and/or when their family and friends chip in. A number of businesses use both debt and equity financing.? As a business builds a financial track record that can be documented by financial statements, using debt financing becomes more viable and is often the preferred strategy.

Which businesses can take on debt?

Any legitimate business can take on debt hence the existence of funding organizations that offer monetary support in the form of grants or loans; that loan right there is business debt and is good for businesses only if the money is invested accordingly. The problem is when you take a million-pula loan from CEDA and buy a Range Rover instead of channeling it towards your business. In earlier blog posts, I highlighted that above everything, an entrepreneur must have discipline because money, especially people’s money, can be very tempting and the same applies with debt.

Large corporate organizations, startup companies and even side hustle businesses can acquire debt. It is all about knowing the right organizations or people to approach and being able to fit their requirements. Furthermore, an entrepreneur should be able to present feasible projections so the investor/lender knows what to expect. Be further prepared to pay anything from normal to ridiculous interest rates. The more lucrative the projections are looking, the higher the chances of acquiring debt or alternatively, where there is equivalent collateral.

Quitting your day job to start a business when you deep in debt is strongly unadvisable as life is not quite like what we see in movies. However, debt shouldn’t prevent you from getting your business going.? If you’re in debt and looking to start a business, you can take the following steps to minimize your startup expenses;

  1. Explore formal financing options.
  2. Look for a cash-ready partner.
  3. Consider other sources of funding.
  4. Reduce personal expenses where you can.
  5. Find a side hustle that can be started within your financial means i.e. Something you can explore using a salary.
  6. Reinvest in your business.

It is not an entirely terrible idea to fund one’s business on a 100% debt but it is an option that can be explored if there are not any other choices to go by. Even funding organizations as big as CEDA will ask you what your own personal contribution to your dream business idea is. And so, it is safer, even for your pockets to try and meet your debtor halfway in your quest for funds.

How can I reduce the amount of interest payable on a loan?

  1. Boost your company?s profitability: The single most important factor a financier will weigh when deciding your interest rate is your company?s financial strength. The more profitable your business is, the higher your chances of getting a lower interest rate. Evaluation will be made on your company?s financial statements to assess if you have a history of profitability; how much profit you?re currently making; and whether your profits are trending higher or lower. Considerations will also be made depending on existing debt within your business.
  2. Offer Collateral: Tangible assets such as a building or land will increase the chances of you getting more money, and lower interest rates.
  3. Raise your credit score:

A credit score is a number between 300?850 that depicts a consumer’s creditworthiness. The higher the score, the better a borrower looks to potential lenders. A credit score is based on credit history: number of open accounts, total levels of debt, and repayment history, and other factors. Your personal credit history serves as another crucial factor in the interest rate you are likely to pay. Your lender/ financier will go on to look into your business?s credit rating to see whether your company has a good record of paying creditors.

For companies, as with individual business owners, a shareholder’s credit rating may not affect the company but in some cases, it actually does. Nobody wants to lend money to people who are not credible and responsible with their own personal funds. Why do you think you fill in your own personal information even when you are requesting funds for a business? It is imperative to have a good standing credit rating. This is not to say a company will be denied funds, but financiers assess all angles before releasing funds. Businesses and companies can get their credit score from TransUnion Botswana, Botswana ITC and Experian Botswana just to mention a few. It is also wise to inquire with bank in use.

Having lived your life without borrowing money ever does not mean you have a good credit score. Contrary to that, you need a credit history to have a credit score. If you have never borrowed, which is mostly the case with younger people, then you will not have much credit history meaning your score will be lower. It may even be that the credit reference agency can’t generate a score for you at all in this case.

Debt and Property

Credit to: Julie Azzi (Australia)

With debt in business, a company can get a loan on top of an already existing loan. As we have already established above, good debt is the kind you acquire to purchase more assets, and in the case of property investors, those assets are additional properties. The plus side of owning properties as an investment is that they always appreciate over time.

There is very little difference in a first-time property purchase difference between the amount of debt you have on the property and the amount the property is worth. But each month, if you are making principal and interest loan repayments you will be reducing the amount you owe on the property. At the same time, the property is appreciating, so the gap between your debt and the value of the home is ever-widening. At some point, it is only logical to cash in on that equity and use it to buy another property.

Constantly Re-evaluate your equity on a regular basis to find out if you?re in a position to cash in on your equity. Most mortgage lenders require a down-payment of at least 10% of the value of the new property. If you regularly calculate your equity, you?ll know when you reach the 10% mark for the next property you?d like to purchase. Once you acquire a property and get it up and running, it?s easy to become complacent. If you want to continue to expand your business and your wealth, however, make a habit of keeping your eye on the next step at any given time. Be on the lookout for properties that suit your goals, and watch the property values in the areas in which you?re already invested. 

The economy is a bit shaky due to the devastating economic effects of the coronavirus pandemic. The irony is that now more than ever is the perfect time to purchase property. The pandemic is not here to stay that’s for sure! And even if it is, economies are slowly adjusting to life with the pandemic. You are likely to buy it cheaper now especially from businesses that are shutting down, but in the event that you get into debt for property, trust that the building will in fact appreciate in value as time goes on.

How To Cut Down Interest On your Mortage

  1. Cut your payments in half; In simple terms, if you are expected to pay 100pula a month for your 20 000pula loan over a period of 18 months, try paying 150-200pula instead and reduce the duration to about 15 months. This strategy has been saving mortgage-holders bucketloads of cash for years.
  2. Take advantage of extra funds:
  3. Round up your loan to the nearest ten.
  4. Get yourself a health check; Consider getting a home loan health check from an experienced mortgage broker, and find out if you can save money by negotiating a better deal with your current lender or by switching lenders.

READ MORE: https://bit.ly/2Q4b2rL

Dodging Tax Using Debt

Using debt is a very common way that companies engage in tax avoidance. Companies use debt to avoid tax; In corporate finance, the tax benefits of debt refer to the fact that from a tax perspective it is cheaper for firms and investors to finance with debt than with equity. Corporation tax is a tax on profit, which is what is left over from revenues after costs are deducted. Interest payments on loans are one of the many deductibles a company can make for corporation tax purposes. In short, the more debt a company takes on, the more interest it pays and the lower its tax bill.  External debt, or debt borrowed from a third party (e.g., a bank) can also be used as a mechanism to avoid taxation through leveraged buyouts, or financial asset stripping. This is to say, a company is bought using borrowed money by a company based offshore. As the acquisition takes place the borrowed money is transferred to the company which has been the target of the acquisition. Often this process involves the target company taking on huge amounts of external debt.

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You might also like this article by Robert Kiyosaki; https://www.entrepreneur.com/article/293759

Miss Victoria Marumo is a journalist with a distinctive and creative voice. Her avid reading complements well with her writing in providing captivating information on business topics.

Writer: Victoria Marumo

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