In 2019, the debt financing advantages seem few and far between. Crippling student loans, maxed out credit cards, suffocating government deficits and someone coming to repossess your Lexus under the withering gaze of your neighbours: this is the most common face of debt.

In 2018, the average debt per adult in the UK was £30,537, equivalent to about 116% of the average income and in 2018, the average UK citizen spent around £1000 on interest alone.

Just a passing glance at our world today will quickly inform you that debt is a plan devised by the devil himself to keep humanity in eternal servitude.

Well, I’m here to try to convince you otherwise.

Debt is good if you have good debt, and in business, credit has been one of the main sources of finance and drivers of growth since time immemorial. The main difference is that borrowing for growth is not the same as borrowing to spend. If you’re planning on using debt to increase your business’ earning capacity, debt can be a cheap and easy way of getting the job done.

There are many reasons why debt should be seen as an ally rather than a foe, and a considered use of credit can give you the edge and land you miles ahead of the competition. There are many advantages to borrowing money and, after using up your internal sources of finance, it could be a great option.

 

 

So, what are the advantages of debt financing?

 

1. VC funding is glamorous but can be cutthroat

Venture capitalists are playing a game that balances high risks with high returns.VCs will finance about one or two firms out of every 100 they see and on average, out of 10 investments, a VC will get a worthwhile return from only one company. That means 98-99% of all companies seeking equity finance will remain unfunded and one out of a thousand firms seeking capital will end up as a good deal for a VC. These odds put the few outfits that manage to get VCs on board and turn a significant profit among very select company.

There are many reasons why you’d want to work with investors, like their expertise, their network and their experience in the markets you want to break into. A VC can be much more than just a wallet, but in reality, venture capital isn’t typical, it’s a rarity. Credit, on the other hand, is how most companies get funded, and it is much more abundant and easier to access.

 

2. You get to keep your baby

I’ll lead with the best argument in my arsenal in the battle of debt vs. equity: Debt means never having to say you’re sorry. Ok, it actually means not having to sell your equity, which is even better.

Even if you’re one of the chosen few who get to the stage where a venture capitalist is interested in investing, they don’t call it a deal for nothing. The VC will be highly incentivised to get as much stock as they can for as little money as possible. It doesn’t mean the VC is acting in bad faith, it simply means they are a rational business person and will act in the interest of maximising returns. You have to keep in mind that a VC is essentially a fund manager who has to balance different investments and maximise returns for their own investors. It’s turtles all the way down.

They might try to question your valuation and hedge their downside through different methods like requesting participating preferred stock, requesting warrant rights or simply arrange the right to kick the founder out of an executive role if they are deemed a bad fit.

Though the VC’s main incentive aligns with the founder’s – the success of the business and maximising returns – there may be different visions of how to get there, and some of these versions of the future might not include you.

It’s true, certain debt financing facilities will need you to provide collateral, requiring a charge on a piece of machinery or a plot of land, but these will only come into play if you default on the loan. An experienced lender will have a cautious approach to collateral and will not rely on these charges, but rather on cash flow projections and other growth indicators to make sure things don’t devolve to the point where you have to sell your grandma’s silverware to make payments.

 

3. Your downside is limited

With debt financing, you know exactly how much you will end up paying the lender: the principal plus the interest for the term of the loan. Full stop.

A key difference between debt and equity financing is that selling stock is certain and permanent, whereas debt is temporary.

Equity involves an obligation to pay dividends for an indefinite term. Every time you want to take profits out of the company, you’ll have to give Caesar what belongs to Caesar. Add to that some exotic liquidation preferences and essentially having someone looking eerily over your shoulder for the rest of your life.

Are you ready for that kind of commitment?

 

4. You’re the master of your own destiny

Remember that time you woke up sweating in the middle of the night, hastily grabbed a notebook and wrote down the best business idea ever? Remember when you nervously quit your job to pursue your dream, making your mother cry and your friends miss you at karaoke night?

These moments will flash before your eyes the second you get outvoted by other shareholders or need to accommodate a few more people at the table when you make decisions. It’s your business, but the more people you invite in, the more voices will need to be heard and the more demands will need to be met. Investors, even those with minority interests in the business will need to have some authority in how the company is run and will invariably arrange to have these rights as part of buying into the business. Again, it’s understandable and rational for the VC to want to have a say in how his investment is managed, but your incentives and ideas might clash.

A lender, on the other hand, just wants to get paid. He’s not going to raise his voice in the boardroom, but he’s also not going to buy a round at the Ivy for the team when you hit your KPIs. The lender will neither help nor hinder.

This is an important aspect to consider depending on where you are in your journey as an entrepreneur. The more mature and experienced you are, the fewer strings and influences you’ll want to have weighing down on your business. If you’re more on the green side, you could benefit from having a few strong voices guiding you away from the cliffs as you navigate your first ventures into calmer waters.

 

5. You get to build your credit score

Just like having a credit card builds your personal credit score, having a loan builds your business’ credit score. Your credit score can go up or down, and the higher your score, the less of a risk your business is deemed to be to lenders.

Companies like Experian or Equifax are in the business of calculating credit scores. They all have their secret sauce, but the main elements that go into a credit score are the usual suspects: the age and size of the credit facility, the ratio between how much credit you can get and how much credit you are using and, last but not least, your payment history.

Commercial or trade scores are used by financial institutions and various types of lenders to assess if you’re the kind of company they’d want to lend to – essentially, if you’re a good bet. Suppliers might also want to check your credit scores if they invoice you on a Net 30 or Net 60 basis. Your credit score is a trust metric for your business in the eyes of the world, so building it with care and consideration will put you head and neck above those for whom building good credit is just an afterthought.

If you’re a good borrower and make your payments on time, it can impact your future borrowing options massively, creating lots of opportunities for growth in the process. Also, keep in mind that the only thing better in the eyes of a prospective lender than you having any charges against your assets is you having charges that have been lifted after successful lends by other financing companies. It tells the lender that they are not venturing into the unknown and that you’re a responsible borrower.

 

6. Your interest is tax deductible and can be cheaper than you think

Wherever in the world you are doing business, chances are your interest payments are going to be tax deductible. This applies to all forms of interest from a term loan to a line of credit and can be a hidden advantage when accessing debt finance.

When you calculate the cost of capital through debt financing, you need to take into account the tax benefit that you get by using the interest as a deduction. So, if the APR on your loan is 12%, you will need to calculate the tax advantage for the period of the interest payments and deduct that from the interest cost. If the corporation tax is, say, 20%, your final cost of capital will be 12% – 12% x 20%, so 9.6%.

Taking the time to consider the tax advantages can help you make clearer decisions on how to source your capital and will help you have a clear idea exactly how much it will cost you to source it. 

 

7. You can use debt for leverage

Using debt to gain leverage has gotten a bad rap because of predatory trading and countless stories of breathtaking losses, disgraced titans and the dark heart of Wall Street. Leveraging debt doesn’t mean you should be short selling, margin trading or engaging in any sort of speculation. Using leverage simply means you can tap into the power of what author Robert Kiyosaki calls OPM (Other People’s Money). If your business has a robust and scalable method of creating value above the interest rate paid to lenders, you can leverage that to increase your ROI.

For companies that develop innovative products and services, another way of leveraging debt is through the R&D Tax Credit. This incentive exists in around 20 countries globally and gives companies a percentage on their R&D investments back. But because the R&D tax credit is a backward-looking incentive and is calculated on the basis of your filed accounts at the end of the year, it’s money that’s very slow to actually show up in the bank. But given that it’s a predictable revenue stream, it’s an asset that can be used to borrow against.

In the UKCanada and Australia companies like Fundsquire can lend against future R&D tax credit revenue. If you’re in the process of growing by investing in technology, you can leverage the R&D tax credit loan by accessing more cash earlier in the tax year and investing it in R&D. This leads to a virtuous cycle where your future R&D tax credit is fuelling your current innovation spending, increasing the size of the final tax credit. It’s about as close to magic as you’re going to get in the world of finance.

What is your businesses’ relationship to debt like? More cold sweats or more heart eyes?

Let me know in the comments.

If you’re curious if an R&D tax credit advance might be the magic you’ve been waiting for, we’re happy to have a chat and see if we can help

 

.