Should You Overborrow?
Is overborrowing a good strategy for your company? At times, you may want to borrow more money than your company currently needs either for anticipated expenses or to keep in reserve.
Overborrowing can be a smart financial strategy if the debt is well managed, your industry is stable and your products or services are in demand. With extra money or lines of credit, your business will have funds available for emergencies and to grow, buy inventory, create new products or services, respond to changing markets or upgrade facilities.
There are some key advantages to borrowing money rather than using cash or business equity. Your company can create a solid credit history by borrowing and repaying loans successfully. Interest is tax-deductible and you can include repayments in your business forecasting as predictable expenses. Another benefit of debt financing, particularly for small to medium enterprises (SME), is that business owners retain company ownership, decision making and profits without having to share these with investors or shareholders. Lenders offer a range of financing options, including term loans, lines of credit, business credit cards, Small Business Administration (SBA) loans, factoring and more. Plus, you don’t need to tie up (or risk losing) your own money in your business, or worse, lose your assets if the business fails or loses a lawsuit.
There are some disadvantages that you, as a business owner, may have to navigate if you overborrow. Debt can constrain your company’s growth. Lenders may limit future loans and increase interest rates if they decide your company is overleveraged.
It is possible to get the same advantages by having a large loan limit but not be required to actually draw down the full amount of the loan. The only disadvantage here is there may be an unused fee associated with the loan.
The best candidate for overborrowing is an established company with low debt, a strong credit rating and a healthy or growing market. You shouldn’t be overleveraging your business if it isn’t profitable or is in a start-up phase—companies in these situations may be better with equity funding, i.e., selling shares or attracting investors. If your business takes on more debt than it can manage—especially if profits or markets drop—this may lead to a downward spiral that can end in bankruptcy or a buyout.
Ultimately, the decision to overborrow varies from business to business. Each company has its own unique financial profile; while one company can comfortably afford to overborrow, another company would find this strategy too risky.