Do you really understand the different business debt types that you can borrow? If not, you might not be able to take advantage of the benefits of using credit in business.
You see, in times of deep crises, borrowing is one of the best ways for a company to survive. You should not ignore this because it can really help your business get out of a tight spot. In fact, it’s highly unlikely that there is a business that does not have some form of debt.
This is especially true during a time like this. According to the latest records, the total non-financial business debt went up during the first three months of 2020. In fact, business debt is now bigger than household debt.
It’s a sign that some businesses are desperate already to survive. They keep on borrowing to stay afloat. If you have a business that you want to save, you have to know that it’s okay to rely on debt. As long as you have a plan to revive your business, you can be free to use credit.
But first, you have to understand what the different business debt types are.
3 business debt types
If you want to save your business from bankruptcy, you have to get financing. Not this financing, will come in the form of debt.
When you hear the words business debt, what comes to mind are the ones that you borrow from financial institutions. That is correct. But there are also other types of debt that companies can also use. In fact, they’ve been using it already.
There are three classifications of business debt and these are based on where the money is borrowed from.
Debt from suppliers
This is probably the most overlooked type of debt. Because it is usually known as payment terms. Every time a business buys something from a supplier, they will not pay immediately. They will choose among the terms of payment, whether it’s 30 days, 60 days or even 90 days. If you chose 60 days, that means you will only be required to pay 60 days after the purchase has been made.
This is a normal practice in business. But what some people don’t realize is that you owe the supplier money between the date of purchase and the actual payment. That is what makes it a form of debt.
It’s not unusual for a business to have multiple payment terms going on. Sometimes, it reaches millions. This is why when a business suddenly is unable to profit, the suppliers are also in danger. If the company can no longer pay their dues, the supplier will also lose profit.
Debt from commercial lenders
This is the business debt type that involves banks, creditors, and other traditional financial institutions. There are many types to be considered here. You have a startup business loan, business credit cards, and even a business consolidation loan.
You also have what they call an asset-based line or simply, ABL. Since a business usually has assets, they will pledge these assets as collateral to the bank. Whatever the value of these assets can be used as the basis for the amount that you can loan, like 60% of the value. Some people use their inventory as a pledge. This means the amount you can borrow will depend on your current inventory.
Structural debt is also another option for business debt types. This debt is dependent on the gross revenue of the company.
Take note of these types of debt so you’ll know that you have more options apart from the traditional business loans.
Debt from investors
The last of the business debt types are those that are borrowed from investors. Sometimes, the money needed is too high that financial institutions or traditional lenders cannot provide it. This is when companies approach private equity investors. It can be one or a group of investors.
These are unsecured debts. So there are no assets attached to it. This can be considered as something similar to a credit card. This type of debt is also very expensive. The interest rate may be higher than 10%. It will depend on the investor that you approached.
What is great about this is that sometimes, investors will take an interest in your business and will give you advice. Some might even be interested in owning a portion of it. If you are struggling with the proper management of your business, they might be a huge help.
But be careful because these investors are still in it to profit. If you will enter into these agreements, make sure you are not on the losing end of the deal.
Why you should consider using business debt
Before you choose among the different business debt types, ask yourself why should you consider it in the first place?
This usually refers to your working capital. This is the money that you use to manage your daily operations. Sometimes, businesses resort to this if they are still waiting for their revenue to catch up with their operational expenses. A short-term loan is usually the best option for this.
Of course, this has to be done correctly. You have to be certain that your revenue will really go up. If not, then you have to reconsider this. Borrowing more may not be the solution. Lowering your operating costs may be a better plan.
But if borrowing is the best course, make sure you choose the option that has the lowest possible interest rate. And one that will be easier for your business to pay off.
Help grow the business
Another reason for you to consider different business debt types is to help grow your business. There are times when the company is doing really well financially. You are able to earn enough profit to cover your expenses. You want to take it to the next level but you don’t have the extra money to do it.
This is where one of the business debt types come in handy. You either borrow from banks or you can borrow from investors. It all depends on how much you need to borrow.
Mitigates your business risk
Finally, if you are trying to save your business from bankruptcy, borrowing money is one of the ways you can do that. This is timely right now because a lot of businesses have filed for bankruptcy after the pandemic. The number of Chapter 11 bankruptcy has risen to records that have surpassed the last 2008-2009 recession.
If you are about to become one of them, you should try to save your business by borrowing money. Usually, if you are on the brink of bankruptcy, you are deeply in the red. That means you need a huge amount of money to recover. Approaching investors maybe your best option here.
When you decide to use any of the business debt types, it’s very important that you know how you’ll pay it off. If not, then maybe borrowing more money is not the solution to your business problems. Sometimes, you have to be honest with yourself about your business. If you are not getting enough revenues, no matter how much money you borrow, you cannot save your business. You’ll just make things worse.