Debt is the hidden land mine in a bad economy
LIf there’s one thing you can count on during an economic downturn, it’s that your business’ flaws will be exposed. Weak marketing won’t convince potential customers to spend money with you. Poor customer service will convince existing clients to spend elsewhere.
But perhaps the greatest business flaw of all is one which can collapse your company from the inside: the accumulation of excessive debt. This common flaw is often hidden from the outside, but it decreases your company’s flexibility during a downturn, increases the costs of your outlays, and reduces the company’s overall growth potential.
Flexibility
The biggest challenge facing companies during a downturn is how to spend suddenly scarce dollars. Should reduced revenues go towards keeping staff, maintaining necessary on-hand product, or paying fixed costs?
Significant working capital allows a company time to make these decisions. Every dollar that goes to debt, therefore, is a burden on the company’s ability to make the wisest decisions possible. Nobody likes to choose between laying off staff and missing bank payments, or keeping the office lit and the bank note, so keeping debt low or non-existent reduces zero-sum payment needs.
Keeping debt low and working capital high also gives a company room to go above and beyond for customers and staff. A highly-leveraged firm, for example, may not be able to keep laid-off staff on company benefits – but a low-debt company can. Discounts to keep customers buying is something a cash-flush company can handle, but which high debt eliminates as an option for other companies. And donations, which have earned companies large and small major publicity wins, are something a company with controlled spending can handle more easily than one which has the bank on its back each month.
Favorable prices, rates, and terms
In good times, successful companies make outlays as cost-effective as possible. During an economic downturn, this practice can be the difference between keeping enough money in the bank to survive and going bankrupt.
Keeping debt low makes this practice much easier because every purchase can be made at your pace, not the one dictated by external factors. A high-debt company’s outlays can cause panic during a downturn; a low-debt company with significant cash on hand can increase its marketing budget while everyone else is retreating. The low-debt company can also take advantage of lower-than-normal prices on necessary company purchases in a strategic and patient way – from office supplies to vehicles and buildings. The high-debt company, meanwhile, continues to leave indents on every cent which goes out the door.
And if you do want to take out a loan during a downturn, low initial debt means you can get the best rates and have the lowest possible monthly payments. This allows you to invest in your company’s future while competitors are stuck paying for the past.
Pay the piper…or build the brand
A popular launching start-up launching strategy is to take on loans or other forms of debt to get off the ground. On the front end, it looks good – get initial capital, make short-term and long-term investments in the company, and get the company off the ground fast. It certainly sounds a lot sexier than bootstrapping your way to success.
However, the piper always gets paid. A company which accumulates debt faster than it accelerates customers and revenue growth is at risk for any economic hiccup. More money cannot be borrowed because the company is already upside-down. Few investors will stick their neck out for a firm that has a high debt-to-income ratio. And if customers dry up, those up-front investments suddenly become anchors on the company’s future.
For most small businesses, especially new ones, keeping debt low allows time to learn what you really do, to discover and reach your target markets, and to set up your company’s long-term structure as more data is received and analyzed. Hiccups become educational opportunities instead of emergencies, and even significant downturns can be survived.
A small business always has two choices – pay the piper or build the brand. Keeping costs and debt low is the way to success.