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Most businesses prefer to incur debt instead of seeking equity financing. It’s easy to see why. In the latter case, they’d have to relinquish ownership of a portion of their business to a financier in exchange for funding. But with debt, they get to retain ownership of their business. All they need to do is pay back the loan they’ve taken.

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Perhaps you’re wondering how you can make debt work for you. After all, many entrepreneurs who accept loans struggle to properly utilize the funds (let alone repay them). This article lays out the steps you can take to get debt financing and use it to grow your enterprise.

Know What You Need Debt For

One thing you should consider is your ability to repay your creditor. Don’t take out a loan unless it’s going to help you boost your business’s productive capacity. The hassle of hunting for funding is stressful enough. You don’t want to struggle to repay while your enterprise isn’t any better for it.

It’s also possible that your needs will be better met by other kinds of leverage. Perhaps equity financing is a better route to go, given the nature of your startup and what you want to achieve with it. Carefully weigh your option, and only proceed when you’ve settled for a path based on the available facts.

Choose A Debt Type

There are two types of leverage (or debt) that your business can take advantage of operating leverage and financial leverage. An example of operating leverage is the credit line that a business can obtain from its suppliers. Financial leverage refers to loans from traditional and novel financial institutions.

Both these options have advantages and drawbacks. Operating leverage involves smaller values, but is relatively easier to pay back. Firms that use financial leverage may deploy it to one of a greater range of needs. But they may be more difficult to repay.
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Think about your needs before going for one of these. If you only want a limited amount of inventory from a supplier, you can ask them for a line of credit. But if you’re looking for larger sums of capital for a potentially wider range of items, you could seek a loan.

Decide If You Can Repay It

We have already hinted at this. You shouldn’t incur debt that you can’t repay.

One way to determine whether you can settle your debt is by measuring your business’s debt-equity ratio. As the name suggests, you can obtain this ratio by dividing your business’s total debt by its total equity (the value of all that it owns).

For example, if your business has outstanding debt totalling ₦1 million and its total equity is ₦10 million, then your debt-equity ratio is 0.10, or 10%.

Experts advise that your debt-equity ratio be no higher than 40%. That’s a threshold for what they consider healthy for a business.

Of course, you should also be certain that your business will generate enough revenues and cash flow to be able to settle the debt you want to incur.

Study Terms And Conditions

Remember, your aim here is to utilize debt to grow your business. So, when you look for loans or other forms of credit, make sure that their terms and conditions are in line with this.

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Are there hidden fees and charges? Can you repay the principal and interest without hurting your business’s growth? Are there fine prints that may be inimical to scaling your enterprise? These are questions you have to answer.

ObtainAnd Deploy Credit

Your chances of securing credit will largely depend on your ability to convince your would-be creditors that your business needs financing. Get the documents that your potential lenders require, and execute a good pitch. You could get them to sign you a cheque.

Use the funding as you’ve initially planned. It should only go to items that’ll grow your productivity, enhance your operations, and increase your revenues and profits. Have a proper plan for this, and execute it as faithfully as you can.

Final Words

Debt doesn’t have to be negative. You can row your business with it. Compare the alternatives for debt financing available to you. Choose one that’ll help you to acquire and maintain growth-spurring assets. Make sure you can manage it over its tenure. And you’ll be on your way to scaling your enterprise via debt.

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This article was first published on 13th June 2022

ikenna-nwachukwu

Ikenna Nwachukwu holds a bachelor's degree in Economics from the University of Nigeria, Nsukka. He loves to look at the world through multiple lenses- economic, political, religious and philosophical- and to write about what he observes in a witty, yet reflective style.

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