The Risk of Debt: When is it a good time for a small business to borrow?

It may seem like a bit of an oxymoron, but good debt can play an important role in the survival of a small business. It’s also been known to take a startup under.

So should a business owner self-finance and grow at a slower pace or take a risk to seize new opportunities?

“Generally, if they’re creeping up where taking on a loan is going to – even with the increased revenue – push them past what they can handle on debt coverage, it might be time to back off and rethink it,” said Derek Fraley, a vice president of commercial lending for BancorpSouth. “Debt for the sake of debt is obviously not good.”

In other words, never as a life raft.

But there is such a thing as good debt. Bankers refer to it as taking on financing for real estate, equipment or capital designed to reach short-term revenue opportunities.

“Hopefully, they’re looking ahead and forecasting,” said Micah Scott of Guaranty Bank. “They need to have an idea of what they need and what it’s going to fund. Hopefully, they’re not saying I need money yesterday.”

Too many companies do. U.S. Bureau of Labor Statistics data indicate about half of private-sector establishments don’t make it to the five-year mark and only a third of them survive 10 years in business.

The Guaranty Bank senior vice president and small-business banking manager particularly recommends bringing on a certified public accountant to determine if taking on debt is a move toward sinking or swimming.

Smoke and fire
The owners of The Albatross Hookah Lounge & Fine Tobacco Emporium self-financed for over six years before deciding it was time to strike while the iron was hot.

The hookah lounge leased at 320 E. Walnut St. before a move in April down the street to 406-A and 408 W. Walnut St. The relocation tripled the lounge’s size to 6,000 square feet, with some $850,000 in financing from multiple sources.

It was a needed move, given at the former store, customers often would be turned away for capacity reasons.

Husband-and-wife owners Chris and Lauren Slater knew it was time for financing four years ago, but obstacles kept lenders at bay.

“In 2010, rumors of the smoking ban came down the pike,” Chris Slater said. “We really couldn’t even think about expanding, because our business may suddenly be illegal.”

Slater worked with City Council to gain an exemption to the rule later passed in 2012.

Still, that wasn’t enough for some lenders.

“We were pursuing financing for The Albatross with a monopoly in my hand,” he said of his city-mandated exemption from the smoking ban. “That didn’t even seem to phase them. It felt like more about the high-risk nature of the industry or the stigma surrounding the industry itself.

“To the outside world, we may look like a head shop.”

However, the business specializing in exotic and pipe tobaccos, cigars, nasal snuff and nondomestic cigarettes, eventually gained traditional financing.

A $650,000 commercial loan from Arvest Bank gave the Slaters ammo needed to pull the trigger on the West Walnut Street building purchased from developer Curtis Jared in December 2013. The couple personally financed another $200,000 to renovate the former sites of Czech Us Out gym and Moxie Cinema, working with Jim Faulkner of Encore Gallery. Around $30,000 came from an RMI Inc. construction loan.

The forward momentum also meant the Slaters became property owners of the building, where they lease four lofts to help repay the debt load. It was an important step, Chris Slater said, because of the value he saw in real estate ownership.

“What The Albatross is paying now is less than what I was paying in rent,” he said of the former lease agreement with property owner Nick Sibley.

Debt free
Not all businesses believe loans are the way to go when growing a business.

BancorpSouth’s Fraley said that’s workable, as long as business owners know what they’re getting into.

“Some people do not like debt,” he said, “but just understand you’re going to grow your revenue more slowly than someone who’s going to take on a little bit more risk.”

All About Trees LLC knows that scenario well.

Owner Noel Boyer borrowed money 11 years ago when he bought the business formerly known as A&A Tree Service. But after paying off the loan, he decided against that path.

“It’s not that I’m scared to be in debt, but I love knowing I’m not wasting my money on interest payments,” he said.

The tree-trimming business has operated frugally, typically buying used equipment and saving wherever possible.

In 2015, All About Trees posted revenue of $1.05 million, representing 23 percent three-year growth, according to Springfield Business Journal archives. Boyer’s company also won the Springfield Area Chamber of Commerce’s 2015 W. Curtis Strube Small Business Award.

The company is about a month out from moving to its new headquarters just outside Springfield city limits on West Bypass. But his tree-care business isn’t taking on debt, true to its character.

Boyer said a separate property investment company, Boyer Smart LLC, bought the 6-acre commercial property in a move that cost him and his wife $450,000 between the purchase and construction of a new facility on-site.

Boyer Smart offloaded some rental properties and is preparing to sell All About Tree’s current headquarters to offset the cost. They expect to pay off the new property in five years. All About Trees will rent the property from Boyer Smart, as it does the current headquarters.

“The main reason is it makes me crazy to look at the interest payments,” Boyer said. “It seems like more money that I get to keep and pay my employees.”