The Power (and Danger) of Business Debt
My company has a line of credit with a local bank. With the interest rate tied to the currently low “Prime” rate, the line is a relatively cheap way for my business to borrow money. Even though our finances are strong, and we have a steady stream of new clients who hire us each month, it is reassuring to know that extra capital is available should the need arise.
Growth by Acquisition: As a business owner, I could also look at a line of credit as way to grow my firm faster. Who doesn’t want to make more money and create greater financial security for his/her family? If I were to “practice what I preach,” an acquisition could diversify my company’s revenue sources. With the banker’s checkbook in my pocket (so to speak), I could “go shopping” for a company similar to my own. This is done all the time on Wall Street ... smaller companies get bigger by buying other companies with borrowed money. Then, they use the revenue from the acquired company to pay off the debt incurred in the acquisition.
What Can Go Right: Let’s say that the owner of another local financial firm is ready to retire, but he doesn’t want to just “close up shop.” He wants to make sure his clients are in good hands. Understandably, he also would like to be compensated for what he has built over the years. Let’s also assume that the soon-to-be-retired adviser calls me because he has heard I am looking to expand (hint, hint). I could use my bank line of credit to make a down payment on his business. Other terms of the purchase might include some of my own cash, as well as an agreement to pay him over time. If all goes as planned, I would end up with a larger company; the former owner’s clients would continue to get great advice and service, and the staffs would combine to form a stronger team ... Not a bad use of debt!
What Can Go Wrong: When housing prices peaked in 2006, inflated housing appraisals allowed banks to offer generous lines of credit. I took advantage of the cheap, readily available money to invest in a start-up company. The business launched very well, but a few years later, it ran into difficulties. As that company’s losses mounted, it became a significant drag on my personal finances, so I had to sell. I ended up breaking even, but it was not fun!
Practical Tips: Debt can be an excellent way to leverage the value of an existing business. It can accelerate growth. However, it isn’t for everyone and it isn’t without risk. Just because the bank will lend to you, doesn’t mean you should take advantage of the loan offer. Run the numbers, and then run them again! Careful evaluation of both your company and the company you wish to acquire is a must before assuming business debt.
David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show at 9AM on AM1380 Ormond Beach, AM1230 New Smyrna Beach and AM1490 Deland. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.