How Much Should You Borrow to Grow Your Business? Consider these four questions before taking on any kind of debt to expand your business.
By Daniel DeMeo Edited by Dan Bova
Opinions expressed by Entrepreneur contributors are their own.
Your business is doing great. You've found your market niche. Your customer base is loyal and growing. The staff (even if it's just you) is stable and knowledgeable. You've reached the point that many small businesses dream about -- demand for your product or service exceeds supply.
Perhaps you've begun to think about what you could do with an infusion of working capital. But it can be a challenge to figure out how much to borrow. Borrow too much and you'll struggle to pay the loan. Borrow too little and your business may not be able to fulfill its full potential.
Taking on any kind of debt requires careful thought. As you think about how much capital you need to fuel expansion, consider these four questions:
1. What is the expected ROI for the loan?
In some cases, the answer is straightforward. Your supplier offers a 30 percent discount on $50,000 in inventory. That's a savings of $15,000. Even figuring in the interest cost and any fees on the loan, that's a healthy ROI.
Similarly, ROI can be strong if you're investing in equipment that will immediately boost productivity and sales. Determining ROI isn't always simple, however. It's tempting to think that doubling the number of restaurant tables will increase sales by 100 percent. Or hiring a new manicurist will allow you to book 12 new appointments a day.
But as every small business owner knows, very few things go exactly as planned. Customers may not materialize, you'll need extra employees and the cost of supplies will jump. When calculating the ROI for the loan amount, estimate low and add in a cushion for unexpected expenses.
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2. Do the numbers add up?
You've built your business by committing your heart and soul to its success. But when it comes to borrowing for expansion, you need to focus on hard data, looking closely at positives and negatives. Positives include revenue and cash on hand, while negatives might include an already-high level of debt and slow sales during certain periods.
Any imbalance can indicate that you need to take a closer look at your business model or operations. Before you consider a loan, be sure your business fundamentals are sound. You want the capital infusion to strengthen your business, not just keep it afloat.
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3. Do you have a game plan for continued growth?
Even short-term capital should be part of a long-term plan. In the short term, you may be planning to use capital to add a new line of products or services or expand to a new location. You could be investing in technology to rev up online sales. You might be adding staff or expanding marketing.
All of these actions should have a singular goal -- understanding and anticipating customer needs. Since there's no business without customers, you need to have a strategy for one, three or five years to keep them coming in the door (or to your website).
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4. Have you identified the right type of lender?
There are a lot of ways to secure working capital. Some people borrow from family or friends. Others use their credit cards. Still others seek funding from a range of lenders and other finance companies. Each case is different. Often, banks are the first place people look, but many banks may be less inclined to fund working capital loans of under $150,000.
As a result, many business owners are choosing to work with online alternative finance companies. Typically, these providers are faster and more efficient. Time-strapped entrepreneurs don't have to compile reams of documents and wait months for a decision, spending time that could be better used running the business. Securing access to funding from alternative finance companies can be as quick as just a few days.
Equally important, online lenders use different criteria when making loan decisions. They may look at sales and revenue data, time in business and other performance-based characteristics. They typically don't require personal collateral or spotless credit from the owner.
Applying with a company that specializes in working with small businesses can increase your chances of getting the capital you need. Just be sure to do your due diligence so you fully understand the terms of your loan, including the total cost of capital and the payment schedule. These factors should inform your decision about how much to borrow.
You've accomplished a goal that many others never reach. You've built a business that is ripe for expansion. By combining an infusion of working capital with a thoughtful long-term plan, you can continue your track record of success. Just be sure you have crunched the numbers and are realistic about the loan's ROI. Then, just keep doing what you do best - delivering a product or service your customers can't live without.
