Good Credit

Don’t let last year’s financial crunch scare you off business loans for good. Done properly, borrowing can provide opportunities that using cash can’t.

Common sense tells us that spending $400 on a bottle of wine to impress a client isn’t worth going into debt over, but what about buying new office equipment or paying for an attractive website? In today’s uncertain economic climate, it can be scary to borrow in order to grow your business. Both bank loans and credit cards might require personal guarantees from a small-business owner, so if the company hits hard times and defaults, you could be on the hook for the debts.

Fortunately, there are some rules of thumb that can help you decide whether or not to borrow money. According to Lawrence Gelburd, a business consultant and lecturer on entrepreneurship at The Wharton School of the University of Pennsylvania, there are many instances when it can help your business expand more quickly than it otherwise might. “Credit should be used in situations where the potential upside is clear, you’re in a cash flow situation that is sustainable and you are not going to put your company at risk,” he says.

It often pays to use credit when it will bring in new revenue. For instance, say a reliable client wants to place a big order that requires you to purchase costly supplies, but you can’t afford to cover them with the cash you have on hand. Gelburd says asking if your supplier will provide you with short-term credit, perhaps by simply extending your payment period from 30 to 90 days or financing the needed materials for you, can help you jump on the opportunity.

It can also be smart to borrow to spread the word about your business. Stefan Doering, founder of BEST Coaches, a Brooklyn, NY, firm that advises leaders of green businesses, recently took out a six-month, $10,000 loan from his sister to help pay for a PR campaign and website, which have been very helpful in bringing in clients.

Similarly, if you are interested in sending a team of sales executives to a trade show or conference where they are likely to attract new business, but you need to use your credit cards to cover the trip, it may well be a prudent move. “If you go to these events and pick up one client or meet strategic partners, customers, suppliers or employees, they can be very worthwhile,” Gelburd says.

When you’re considering taking on a larger debt, think about its total effect on your business for the period of the loan. If you need business equipment that is so expensive that it would drain your cash reserves to buy it outright, securing a financing deal that requires low monthly payments would be wiser, even if it costs you a little more overall. “[Paying in installments] is a wonderful vehicle for businesses to use in terms of cash flow,” says Norm Bour, a principal at Opis Network, a business marketing company in Irvine, CA.

Taking on small debts can also pave the way to stronger credit—and lead to better loan deals—in the future. Pamela Waterman, who runs The Discovery Box, a small cookbook publishing company in Mesa, AZ, took out a $3,000 loan from her bank in 2007 to help pay for a print run and related expenses. She paid the debt off every month, and in late 2008, her banker was willing to give her another loan for a new project—despite the credit crunch. What’s more, her bank lowered the interest rate from 11.5% to 6.5%. Waterman believes her decision to borrow helped her focus on important marketing efforts, such as commissioning a professionally designed brochure and redesigning her website. “The saying that you have to spend money to make money is, for the most part, true,” she says.

Regardless of your reasons for taking on debt, make sure you keep other expenses in check so you aren’t forced to make late payments that lead to a spike in interest rates. Before borrowing $12,000 on a low-interest credit card eight months ago to self-publish No Limits, a book about how to trade the corporate life for an entrepreneurial one, software developer Sara Morgan halved her monthly expenses by moving from Baton Rouge to Saint Francisville, LA, where she could buy a less expensive home and enroll her three children in public schools on par with the private schools they used to attend. Sticking to a tight budget has already allowed her to reduce her business debt to $8,000. “Now that I’m starting to see some money coming in from book sales, I’m going to pay it down,” she says.

There is one time you should never borrow: when your company is failing. As Bour puts it, “A lot of people make the mistake of thinking more money is going to solve their problems.” While it may be hard to admit that your business model doesn’t work, sometimes it is best to cut your losses early. Just ask Angelique Lochridge, who started a business with her husband renovating and selling homes in Tampa, FL, in 2003. When the real-estate market tanked, it was hard to find buyers. To keep up with $18,000 in monthly mortgage payments for five homes, they raided their savings, maxed out their credit cards, borrowed more than $100,000 on their home equity lines and turned to friends and family members for loans.

Today, the couple owes more than $50,000 on their credit cards and more than $100,000 to family and friends, and they wish they had planned their debt much more carefully. “We should have really looked at whether the business had an opportunity to spring back,” Lochridge says. That said, if you’re in a position to handle it, going into the red can earn your business a lot of green.