Coates & Davenport, P.C.

5 reasons debt can be good, but can still lead to bankruptcy

For five years, you tried to avoid all business debt. You had some cash on hand to start the company. You started small and tried to scale things up as you went. You ignored bank loans. You didn't even want to ask investors for money. If all of the money was your own, you stayed in full control.

Moreover, you wanted to avoid a financial disaster that could ruin your young company. You had always heard that debt was a negative, something to avoid at all costs.

Good debt

Fairly quickly, you learned that your line of thinking was not fully accurate. Debt isn't always bad. You can absolutely rack up good debt that helps your company grow. It may even be nearly impossible not to do so, depending on what industry you work in.

Here are five examples of good debt:

  1. Money for expansion: Your business is successful. You want to grow quickly to meet the market demand. Perhaps you want to open another branch. Debt allows you to do something you know will prove profitable.
  2. Hiring new talent: Your company needs new workers as it expands. Plus, you do not want to grow stagnant. Bringing on new talent costs money, but it can increase revenue in the long run.
  3. Offering new services: Your customers reach out and tell you what they want. Responding to them makes your company an industry leader, a company people can trust.
  4. Developing new products: Again, growing stagnant is dangerous. You want to expand your product line. You want your existing products to evolve. Innovation keeps people engaged and offers them new things they did not even realize they needed before.
  5. Acquiring other companies: As your business grows, you acquire related companies to complement what you already do. For instance, perhaps your company helps create and run websites for other corporations, and then you buy up a smaller company that runs web stores. This allows you to integrate stores into your own designs for your clients.

You may have started with no debt, but can you last?

The debt ratio

The problem is when your debt ratio slants too heavily. You owe more than you're taking in. Income and cash on hand cannot match monthly payments.

You may be able to cover this in the short term, either by spending money you saved up, investing more of your own money or liquidating some assets to pay your debts. If your cash flow never increases, though, you can run the business right into bankruptcy.

For example, you develop a new product and hope that sales will double. When it gets released, sales only increase by 10 percent. That cannot cover your debt from product development, marketing and all related costs.

Your options

When debt that seemed good turns bad, make sure you know all of your legal options. This could include bankruptcy, which may give you a chance to eliminate debt or reorganize.

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