Many business owners struggle with establishing the appropriate capital structure of their companies.  New business owners see debt (i.e. bank loans) as a quick and easy way to raise capital for their start-ups.  More senior entrepreneurs may shun debt and prefer to raise equity capital for their ventures.  Ultimately, both groups debate whether or not debt is bad.   The answer is, “It depends.”  It depends on the maturity of your business and your current financial situation.   New Businesses For new businesses, debt can seem like an easy way to raise capital.  A new entrepreneur may consider the local bank as a first resort for funding.  The issue that new businesses face is uncertain cash flows.  With a properly developed business plan, an entrepreneur will have projections of future cash flows, but application does not always coincide with theory.  A business typically requires a “ramp-up” period to begin generating stable cash flow.  Debt can be very unforgiving of uncertainty, as it will require a business to immediately begin paying back their loan during this ramp-up period.  This can make holding debt difficult for new businesses.     As a new business, it is critical to select financing that meets the needs of your business.  If you choose to raise debt, ensure that you have a good understanding of:   ·         The borrowing rate (interest and principal) ·         Term (payback period) of the debt ·         Penalties for late payments / Default period ·         Future intent to raise equity capital   Newer businesses may want to consider approaching angel investors, venture capitalists for either “convertible debt” or “preferred equity” financing.  This is not the easiest financing to secure or maintain.  You will want to ensure that your business plan and financial projections are rock-solid.  You should also consider whether or not you want a “business partner” involved in your business, looking over your shoulder.  That is what you may gain with capital from an angel investor or VC.   Mature Businesses Mature businesses may prefer to pay-off their debt and focus on growing equity capital via angel investors, or venture capitalists.  Once you have achieved a position of stable and steady (predictable) cash flow, then debt can become less of a burden and more of a benefit.  Depending on your corporate structure, your interest payments provide you with a tax shield – deductable tax benefit based on your corporate tax rate and your interest payment.     The potential drawback is the seniority of debt.  If you are planning to solicit angel investors and/or venture capital for equity investments, they will hold subordinate positions in our capital structure.  This means that if something happened and your business shut down, they would only be paid after the bank (and other debt holders) were paid.  This means that they may require a higher interest rate if you are holding debt, in response to that risk.   Regardless of the maturity of your business, it almost always make sense to have some form of a “line of credit,” in the event of an emergency.  This can serve as your emergency reserve if you either do not have a capital reserve or would rather not touch your cash reserve for liquidity purposes.   So, the implication of holding debt depends on the maturity of your organization and your financial situation.  Feel free to e-mail us if you have additional questions.