Almost 80% of small business owners self-fund their start-ups through savings, family, friends, or credit cards. While these sources are relatively easy to obtain, at a certain point, additional funds may be needed for expansion. This is where long-term debt is an option.
Long-term debt is defined as a loan with payback period longer than one year. This is in contrast to shorter term debt such as lines of credit or short-term notes. Longer loans can be used to purchase real estate, equipment, vehicles, and inventory. In some cases, working capital can be funded this way. Generally, the term for a commercial real estate purchase is 20 years. Terms for equipment, vehicles, and other business assets generally range from three to ten years. Interest rates vary by source.
Maximize your Equity
One of the main benefits of a long-term loan is leveraging your existing equity to purchase additional assets. Instead of saving money for new equipment or continuing to pay rent, you can buy the new asset now. Lenders want to see a down payment—usually 10 or 20%—so be sure to have that additional cash on hand. With vehicles or equipment, sometimes you make a trade-in instead of using cash. The new asset will also appear on your balance sheet, along with the associated debt. As long as debt and equity remain in the right proportions, this enhances your business position.
Even Out your Cash Flow
Another advantage of long-term debt is that the payments are fixed for the life of the loan. You know in advance how much they are going to cost each month. Other financing tools such as lines of credit require lump sum payments periodically. It may be more difficult to find the funds to make these larger payments. At times, inability to repay a line of credit has resulted in the lender rewriting the note as long term debt. However, you shouldn't count on receiving this favorable outcome.
Build your Business Credit
One major disadvantage for many small business owners is that they use their personal credit for business expenses and therefore don't have a business credit history. A business loan will help you build your credit record and position you for additional loans in the future.
Although long-term debt has many advantages, it should be used sparingly and with an eye to the overall goals of the company. Businesses that take on debt in a haphazard fashion may find themselves constrained by too many debt payments. They may also limit their ability to take on additional debt when a golden opportunity to expand presents itself. Therefore, it's wise to keep an eye on debt and equity ratios so your balance sheet remains healthy.