Avoiding debt, whether it’s in business or at home, always seems like the right idea. But in the business world, taking on debt might be smart in the current economic climate.
“If you’ve got the stomach for the risk, debt right now is very attractive from an interest rate standpoint,” said Ben Harvey, owner of Harvey Financial Group and a wealth management advisor at Northwestern Mutual.
Mark Perrault, another Northwestern Mutual financial advisor and co-owner of Dunn Perrault & Associates, figures it’s the right time for many businesses to take that risk.
“It’s a great time to leverage debt with a small business,” said Perrault, who primarily works with business owners and the self-employed. “Interest rates are low and the economy looks good.”
Still, avoiding debt or eliminating accrued debt is the goal for many businesses — and especially individuals.
“Debt creates risk,” Harvey said. “The more debt you have, the more risk you assume. It takes a lot more cash flow to service that. It can feel burdensome, like you’re trying to get the rock up the hill and you can never quite get out from under it.”
Northwestern Mutual’s Planning and Progress Study is an online survey of 2,749 adults who have debt. How far in the hole are they, on average? About $37,300, according to the study — and that doesn’t include mortgages. According to the study, 47 percent had personal debt in excess of $25,000 and 26 percent were above $50,000.
“I think people sometimes get stuck in their current situation without thinking how it could be better,” Harvey said.
Perrault has quick advice for people with that much debt.
“Literally get rid of the credit cards,” he said. “Or hide them. Go to cash, because credit doesn’t hurt enough.”
He cited an example that reveals much about the human psyche when it comes to spending.
“There was a study done with Boston Celtics playoff tickets,” Perrault said. “It showed that people were basically willing to pay up to $500 for a ticket with cash. But if they paid with credit they would pay $1,000 for a ticket.”
Debt as leverage
Harvey has many clients with debt — both business owners and individuals. Either way, he helps them create a road map to eradicate debt and build assets.
“Business debt is very similar to debt on the personal side,” Harvey said. “It has to do with money coming in, money going out … how they feel about the debt … are they risk takers? … Can they negotiate with the bank to see if they can get a better deal?”
Harvey knows many business owners and entrepreneurs don’t hesitate to go deeper into debt.
“We’ve got a couple of clients who have loans at very low interest rates and they feel they can generate four or five times in business what the interest rate is,” he said. “So if they can do that, it’s a great win-win. Savvy people understand leverage.”
Corporations flush with cash are still taking on debt because it’s so cheap right now, Harvey said. They feel that debt is better utilized for research and development or inventory management “or whatever comes up for them,” he said.
“And small businesses can do it in the same way,” Harvey added. “It’s just the concept of leverage: If I can get a low interest loan and manage the cash flow, and I’m willing to take that risk, then I could see huge, exponential growth from investing in my business. And that’s where debt can be a really valuable tool to expand and manage your wealth.”
Debt-free, for now
Ian Lee preferred to take on personal debt when starting Lee Spirits in 2013 and its tasting room, Brooklyn’s on Boulder Street, about two years later with his cousin, Nick Lee.
The Colorado Springs-based entrepreneurs also recruited about 20 small investors to raise $165,000 and have managed to keep the business debt-free.
Ian is one of the Business Journal’s “2017 Rising Stars” and he is focused on growing Lee Spirits. The company sells gin and other spirits to bars and restaurants in Colorado and Arizona, with plans to expand into Nebraska, Kansas, New Mexico and Nevada by summer’s end and perhaps into Missouri and California by next year.
To do that, Lee may take on business debt.
“Whether we take on debt depends on what we experience when we move into those new states,” Lee said. “Like if we’d had an extra $10K would it have made a difference? And if the answer to that is yes, then next year when we try to launch into a few other states, it would be logical to have a financial vehicle like that at our disposal.”
Ian was personally debt-free when he started Lee Spirits, but chose to assume credit card debt to help fund his latest dream, which expanded into a brick-and-mortar business.
“There are always two sides of the coin, though,” he said. “As a founder, you’ve got to deal with your own household and you’ve pretty much got this other kid — which is your business — and you’ve got to make sure they both stay healthy. For me to have income now, I’ve got to make sure the business stays healthy. Nick and I take salaries now, but not huge. We’ll pay ourselves more as time goes on. When we started, I took a bunch of money out of a 401k, out of my stock accounts.”
Ian said he is comfortable taking risks, and isn’t afraid of debt, though he has set a limit: no more personal debt than he could make in a year if he went back to an engineering company; his degree is in IT management.
“That’s my sanity check on how crazy this is getting,” he said. “That feels like what’s inside my control. Everyone’s got a different level. And maybe that’s not inside my control but that’s where my emotional acceptance is while we’re growing the business, while there are ups and downs on the roller coaster of being an entrepreneur. Obviously, the more I can chip away at my debt while I’m working on a startup, the longer time I’ve got [to grow the business].”
Sacrifice and discipline
Perrault counseled Ian before he started Lee Spirits and Brooklyn’s, a Prohibition-style speakeasy.
“Brooklyn’s has done phenomenally well,” Perrault said. “I’m naturally a skeptic about people starting a business. It’s extraordinarily tough to be an entrepreneur. It takes resiliency, and I challenged Ian on that more than the finances, although we talked at length about how deep he should go into debt.”
For a startup, it’s difficult not to acquire debt immediately.
“There are lots of companies that have to start with debt right away, because they’ve got capital they’ve got to buy or they’ve got lease payments,” Harvey said. “Even if they have outside investors, a lot of times that cash is in the form of a note, debt that has to be paid back over time.
“If you’re over-burdened with debt, maybe you can find an equity investor who’ll buy a piece of the business to give you a cash infusion so you can retire the debt. But you give away equity, so you have to decide if that tradeoff is OK with you, because you’re giving away profits in the future.”
Asked about pitfalls to avoid, Perrault said, “High fixed expenses are the No. 1 problem. Space is for ego; rent is forever. It’s better to start small and expand rather than start big and have to scale back.”
Sacrifice and discipline are important in curbing business and personal debt, Perrault said.
Harvey and Perrault advise paying off higher-interest debt first, but say the “snowball effect” works better for most people.
“The plan has to be tailored for them,” Harvey said. “Some people are very analytical and they’re fine paying the highest interest first, which makes the most sense financially. But we’ve found it’s best to start with the smallest debt and knock that out as soon as you can and take what you were applying to that and apply that to the next smallest one. That’s not necessarily the most financially perfect way to do it, but it’s usually the most successful human way to do it.”