Is Debt Bad for Your Business?

August 14, 2023
The Profit Plot


Picture this - you're standing at the edge of a cliff.

The ground is dry and cracked around you. You nudge a small rock off the edge in front of you and watch as it plummets down, down, down to the bottom.

You look up, and across the sprawling expanse that stretches out in front of you is the other side! There's grass growing, flowers sprouting up from the ground, and beautiful countryside beyond.

You need to get to the other side. It's what you were born to do! It's the reason that you were put on this Earth.

But how?

Well, you could build a bridge.

It'll take time and a heck of a lot of resources, but it's safe. You know how to build a bridge: in fact, you're pretty good at it! When it comes to bridge building, you're the best there is.

You'll find people who are passionate about getting to the other side and get them to pitch in. You'll gather resources slowly, and, after a while, you'll get across.


This whole process... It's a lot. You might be able to speed it up if you had access to more resources. You've got a friend who knows someone that can fly you across - they're a helicopter pilot. But, in exchange for your safe passage, they'll want some of what's on the other side for themselves.

Is it bad to take the shortcut? To fly across the chasm even though you know you could get across (eventually...) by yourself?

The answer is... it's complicated.

[Intro music]

Welcome back to The Profit Plot, a podcast where we help small business owners unlock the story behind their profitable business by unpacking one complex financial topic at a time. I am your host, Jeremy Millar.

Today, we're talking about debt. Is borrowing money to grow your business a good idea, or a dangerous trap you should steer clear of at all costs?

We'll be discussing what debt is, how it works, and why it's such an essential but hotly debated tool that you should consider keeping in your financial back pocket for the right time.

Debt is something you may already be intimately familiar with. Maybe you're caught in the chokehold of crushing credit card debt and have started Dave Ramsey's Baby Steps hoping to bail yourself out.

Or, maybe you're financing your entire existence because you just finished reading Robert Kiyosaki's Rich Dad, Poor Dad.

Whatever your views on debt are, good or evil, you likely know it as borrowed money.

But, what is money?

Most of us go our entire lives without ever stopping to question what allows us to buy groceries, pay the water bill, or generally live in our homes. Money is so deeply interwoven into the fabric of our society that it feels like it's always been there.

Partly because it has.

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Not in the form of green bills in our wallets or numbers that tick up in our bank accounts. Before money was green, it was gold and silver; before that, it was just an exchange of goods and services.

Money, at its core, is just a promise.

Before currency was invented, humans traded things or deeds.

I'll trade you this fur pelt in exchange for some salted meat. I'll give you three fish for a pair of shoes. I'll make you a set of tools if you give me a bushel of wheat, and so on and so forth.

But promises like these often take time to be fulfilled! You may need my set of tools to harvest your wheat, which means I have to give them to you on the merit of your promise. I have to trust that you'll return back with my food if I give you these tools.

Societies slowly evolved and changed. Governments were formed, and bigger promises were made. The king's army will protect his citizens if they work the land. Societies needed a way to standardize the exchange around the promises being made.

In 600 BCE, the kingdom of Lydia minted what is believed to be the first official currency; taxes were now payable in the currency of the land, and trade became easier than ever.

Over time money has drastically evolved. Now, most countries leverage their banking system to create money. Banks receive a governmental charter, effectively a license to offer banking services, allowing them to also lend money.

Banks must follow stringent rules and regulations, but in today's world, they are the source of money in society's circulation.

Our society is still based on promises but in a far more efficient system. When I do work for a company, I'm paid according to my agreed-upon hourly wage. I fulfill my promise to the company I work for by accomplishing my job and the company I work for fulfills it's promise to me by giving me a paycheck.

I can then use this paycheck to purchase food, pay taxes, and of course, take on debt.

As a small business owner, when I come to a bank and ask for a loan of $50,000, my application is reviewed to determine my "creditworthiness." In other words, everyone applying for a loan is evaluated against certain criteria determining their ability to repay the loan.

When a new debt is issued, there's a risk that the amount of money being lent won't be paid back. What happens in the event that my bank doesn't get its $50,000 back because I can't pay it?

The lending bank attempts to determine the level of risk at which they're lending this money by evaluating your promise to pay it back through a process called underwriting.

Does your business have a good history of payments? Do your financial statements show healthy growth? Will you personally guarantee that your loan will get paid back, even if you have to do it out of your own pocket?

If you can pass through the underwriting process, you're guaranteeing to the bank that you'll pay back all of their money.

It doesn't stop there, though. In exchange for taking on the risk of lending out money, banks charge interest.

Interest is the price that you pay to borrow money. As I mentioned before, it's the bank's way of getting a return on the cash that they're lending out in exchange for the risk that they're taking.

When you borrow money in any circumstance, you're responsible for paying back the base amount you've borrowed over a set period. For example, if you take out a $50,000 small business loan under a 10-year agreement, you must pay back that $50,000. This is called the principal. In this example, your payments are due every month for the next 10 years until you fully repay your loan.

An interest rate is a set percentage agreed upon when funding your loan, calculated based on the principal you owe. As you make payments to reduce the principal amount that you owe, the portion of your payment that goes to interest shrinks over time.

This is why debt can be so dangerous.

It can be easy to make promises, but it's a lot harder to keep them. Unfortunately, many business owners who don't understand how debt works find themselves swallowed up by it.

Without proper financial management and understanding of cash flow, your debt can easily sneak up on you and become unsustainable.

Debt can also be a massive psychological weight. Many banks require that entrepreneurs personally guarantee the funds that they're seeking, meaning that you are personally liable for paying back the money. This can be a huge weight on your shoulders, which can lead to difficulty leading the business and making clear decisions.

It's so important to know how debt behaves and how you behave with debt. Knowing what your payments are going towards is one thing, but understanding how to use debt is a different story.

Again, money, at its core, is a promise - and debt is as well by extension. But for business owners, it's often a promise made in the hope of getting to the other side of the cliff.

You may see a clear path forward from where you are, but building a business is rarely straightforward. All kinds of pitfalls can arise at a moment's notice, which can spell death for your business.

When you're lifting something extremely heavy, it can be useful to utilize a counterweight for leverage. Another object or a tool that allows you to maneuver something that would normally be impossible to lift easily.

Debt is a counterweight that can be used for leverage.

Imagine that you're selling candles online through Shopify. You've found a strategy that has been absolutely explosive for your business so far - a combination of user-generated content, Facebook ads, and carefully constructed landing pages.

Your small-scale tests have shown enormous profit margins when using this strategy.

But there's a problem.

You don't have the capital in the bank you need to buy a lot of product at once; you need to scale this approach incrementally!

If you have an accessible business line of credit, you can draw upon debt to purchase more products and scale up your winning marketing strategy. You do this incrementally so that you can carefully watch for diminishing returns from your marketing and ensure you don't over-extend yourself.

This is an example of successfully using debt as a form of leverage! You've got a proven strategy for selling products; you just need more weight behind yourself to get things really going.

Debt is an incredibly divisive tool. It can help your business grow exponentially and it can also contribute to extreme stress and anxiety. Taking on debt is always an incredibly personal decision; it's specific to every circumstance, every business, and every individual.

And so, we find ourselves back at the edge of the cliff, a deep chasm of the unknown before us. Yeah, you could take the long route, building a bridge with the tools and resources you collect over time.

It's slow, it's safe, and it's a great path well-traveled by many.

Or you can choose to fly, to embrace the opportunity for growth that debt offers.

Hear me, though: it's a risk.

You'll have to share the spoils of the other side with the one who got you there. There's no guarantee that you'll make it in the first place! But, when used properly, this leap of faith can put you leagues ahead of where you would be if you had chosen the long route.

The question isn't whether debt is good or bad for your business. The question is, can you bear the weight of the promises you're making?

In the right hands, debt can be the wind beneath your wings, carrying you across the vast expanse to reach the fertile grounds of growth and success. But it can also be the force that pulls you down, deep into the depths of the chasm, if not handled with care.

So as we close today's conversation, I implore you to consider this: debt is a tool, not a solution.

It's a means to an end, not the end itself.

Whether it turns out to be good or bad for your business entirely depends on how you use it and how prepared you are to meet its demands.

And remember, no matter which route you choose, the journey is just as important as the destination. So keep learning, keep growing, and keep unlocking your financial story, one decision at a time.

As always, thank you for tuning in to The Profit Plot. Make sure that you're subscribed to The Profit Plot podcast on Spotify, Apple Podcasts, or wherever else you get your podcasts from and share this episode with a fellow entrepreneur. The more we learn, the stronger we become, and the wider the bridges we can build.

Join us again soon as we venture to unlock the financial story behind your profitable business. Looking forward to having you here with us next time, on The Profit Plot.

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Jeremy Millar
Written by:
Jeremy Millar

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