Chances are, if your business is at all successful, you are going to confront that question. At some point, you’ll need to fund your business growth: a larger space, more computers, more sophisticated software, and more equipment.  You’ll have to buy raw materials, build your inventory and hire additional people.  You’ll need to invest in continual training and developing your people.

All of this requires an upfront investment of money, invested with the hope of it bringing a return and growing your business’s size, profitability and impact. And, of course, that investment is made with the risk that it may never work out the way you’re planning.

So, you’ve prayed about it.  You’ve run the numbers, considered all the alternatives, and you’ve come up to a set of conclusions:

1. You should grow your business.
2. This is the time and opportunity to take the next step.
3. It requires more money than you have.

Now, you are faced with the decision.  How do you fund it?  Where does the money come from?

There is an answer out there in the compendium of worldly wisdom.  Depending on the size of your business, the conventional wisdom says that you go to the bank and borrow the money.

Does that knee-jerk reaction, and off-the-cuff advice hold true for a Christian business?

Nuances

In our 21st Century business world, we should recognize some nuances when it comes to business debt… Not all debt is the same and some debt is less onerous than others.  For our purposes, debt can be characterized and classified in several important ways. When considering taking on debt, we should keep these issues in mind.

1. The relative amount.

It’s one thing to owe $1,000 and it’s another to owe $1 million. If you are a sole proprietor, the $1 million debt might be staggering. However, if you’re a Fortune 500 company, it may not be even noticeable.

For a business, the real issue is the amount of debt payment relative to the cash flow.  The greater the ratio of cash flow to payment, the more acceptable the debt is. For example, if you are bringing in $100,000 per month, $1,000 a month debt is 1/100th of your cash flow.  That same $1,000 is 20% of your cash flow if you are averaging $5,000 a month.  Clearly, the smaller the percentage of your cash flow the debt requires, the less dangerous that debt is.

Another way to look at the relative amount of debt is the asset to debt ratio.  This looks at your business assets and then compares the total amount of debt to the total assets in the business. If, for example, your total debt exceeds your assets, you are in jeopardy of going bankrupt.  So, the lower the debt to asset ratio, the more tolerable is the loan.

2. The purpose of the debt.

Again, it’s one thing to borrow money to acquire a new piece of production equipment, and it’s another to do it so that you can re-decorate the corner office.  A long-term lease on a production facility is one form of debt, a credit card bill for entertainment expenses quite another.

3. The means and type of commitment for repayment.

For example, you may create a royalty payment for a lender, where he is repaid by a certain dollar amount or percentage of every sale of a product or service.  In that case, the lender assumes the risk of bad sales and little repayment.  If the product doesn’t sell, he doesn’t get paid back.  If it does, he makes an excellent return.  On the other hand, you may decide to personally borrow $100,000 and put your house up for collateral.

4. The quality and type of lender.

It’s one thing to borrow the money from your family and friends, and quite another to get it from the bank across town.  It’s one thing to have a vendor finance your purchase of a piece of equipment, and quite another to acquire the funds from the loan-shark downtown.

5. The cost of the debt.

Typically, the interest rate that you will pay to the lender for using his/her money can take lots of different forms, from the points you pay at the beginning of a mortgage, to the penalties you pay for missing a payment. It’s common sense to understand that lower-cost debt is preferable to higher-cost borrowing.

For a business, not all debt is the same.  We can use these five criteria to assess the quality of the debt we are considering, and to alter the terms in our favor when possible.

One other thought…

Before we go any further, let’s put the issue of debt into a larger framework.  Borrowing, in all its forms, is a way of bringing other people’s money into the business. For whatever reason, you have a need for money, but your business doesn’t have enough of its own. So, you need other people’s money to fund some aspect of your business.  Borrowing is one choice, but it isn’t the only choice.

Options

You can access other people’s money by selling equity. You can, for example, sell a portion of the business and have a minority stockholder.  Or, you can create a limited partnership for a specific purpose and sell partnership shares in it.  Or you can sell an interest in a specific product line, production line or branch office, for example.

When you need other people’s money, borrowing, and creating debt, is only one of the choices. If you must acquire other people’s money, think carefully about the structure of the debt, and use the most favorable structure.

Let me illustrate this example.  Let’s say that you own a tool & die shop and have a customer who will commit to regular purchases from you, but you need to acquire a new piece of production equipment in order to service the order.  The equipment is going to cost $100,000, or about 15% of your current cash flow.

The customer will commit to buy about $8,000 a month.  At a 50% margin, that will spin off about $4,000 a month in new gross profits.  If you applied that totally to the $100,000, you could pay it off in about 25 – 30 months, depending on the interest rate.  You are pretty sure you want to do this, if you can figure out how to finance it.  Here are the possibilities:

1. Royalty.  Under this structure, you find someone to provide you with the $100,000. Instead of a repayment schedule with interest, you offer a royalty of $1.00 per unit produced by the machine until he/she has received $115,000.  The terms are such that if you don’t sell enough to pay back his initial investment, you don’t owe anything more.  He is basically investing in the machine and you by taking some risk in return for a greater return.

You are transferring the risk – and some of the profit — to the investor and agreeing to less gross profit in return.

This has the advantage that your debt is tied to a royalty.  You have no personal responsibility.  If your customer goes out of business and the machine becomes idle, the investor loses, as do you.  You can sleep at night.

At the same time, you bring a knowledgeable investor into the business, and he/she can make a determination about the viability of your deal.  If it doesn’t look good to the investor, it may not be right for you. There may be aspects of it that you have overlooked but seem obvious to him.  You may get a free analysis of the arrangement as part of the deal.

1. Limited partners.  This is similar to a royalty, only it requires the creation of new business entity – a limited partnership – and the partners have an interest in the losses and gains of that entity.

In this case, you find four (or some such number) people to invest $25,000 each. You form a limited partnership to buy the machine and contractually agree to split the proceeds of the machine’s output 50/50 (or some other agreed upon formula) between you, the general partner, and them, the limited partners.  Limited partners have no say in the running of the business or the machine. They are ‘silent.’

Limited partners own a percentage of the partnership, and losses as well as profits pass through to them on the agreed-upon rate. One advantage of this structure is the same as with a royalty.  You bring experienced, outside people into your business and they view your offer from a different perspective.  If you can’t get anyone to come into the partnership, maybe something is wrong with the deal.

The limited partners have no stake in the greater business, they only have an interest in the machine.  So, if the deal goes sour, your other assets are safe. This arrangement has the same impact on your emotions as the royalty.  The investors understand if those things don’t go the way you expect them to, they may lose money. You are not personally responsible for their investments.

I funded the publication of my first book, way back in the early 90’s with this approach. I didn’t want to borrow the money, so I created a limited partnership and sold shares to five of my customers. They received a fixed percentage of the gross profit.  This worked out well for me, as these customers showed enough confidence in me and my message to put their money behind it.  They helped market the book, and eventually got double their money back.  I published the book debt-free, and it eventually became the best-selling book ever published in that niche.  This structure cost me more, but I didn’t mind, as my book blessed the investors, blessed the readers, and was one of the stimulants that fed the growth of my business for years.

1. Equity sale.

Under this structure, you sell a percentage of the company for $100,000. You owe nothing, but you own a little bit less of the business.  This may not be as intimidating as it sounds.  Minority stockholders, in a closely held business, have little say in the management of the business unless you want them to.  If you pay dividends every year, then you’ll get a little smaller piece of a little larger pie.  If and when you sell the business, you’ll receive a little less, as a percentage, of what should be a little more, in absolute dollars.  The advantage is that you owe nothing.  You’ve attached no debt to the company.

All of the structures above bring you the capital you need to buy the new machine without creating debt that you are personally liable to pay back.  The next two structures don’t have that benefit.

1. Secured loan

You make an agreement with the bank to lend you the money to buy the machine, and the bank attaches a lien on the machine.  If you don’t make the payments, they come and get the machine.

Another variation on this is to have the machine vendor do the same thing. You agree to pay for the machine over the next 24 – 30 months, making monthly principal and interest payments. If you miss the payments, the vendor retrieves the machine.

The advantage of working with the bank is that you have a credible outside source look at the deal and affirm that it looks viable.  Otherwise, they would not lend it to you.  The disadvantages are all the disadvantages of debt. You will pay interest on the loan, and you will have the obligation to make those monthly payments, regardless of the success of the project.

The one somewhat mitigating factor is that the machine is security for the loan.  If they take back the machine (depending on how the loan is written) you are out from under the payments.  You have ruined your credit rating, and lost a bank, but you may be free of the necessity to pay back any remaining balances.

The vendor may be a bit more eager to do this deal with you as they are making money on the sale of the machine as well as the financing. Think of automotive dealer financing, for example.  They may not take as critical a look at the viability of the deal as the bank would, and, because of the profit on the machine, may be easier to negotiate more favorable terms.

1. Unsecured loan.

In this structure, the bank gives you the money and doesn’t attach the machine as collateral.  They may provide the money on your signature.  For a Christian, no matter what happens, you now have the obligation to pay back this loan.  Regardless of the life and viability of the machine, you have given your word and are on the hook for the total amount of principal and interest, no matter what.

Bottom line

Go slowly when it comes to putting the company into debt. Consider the alternate approaches. There are multiple ways to acquire other people’s money.

If you’d like to dig deeper  onto this issue, get “The Christian Guide to Financing Business Growth” – a free E-book here.