By Bilal Mufti
Are you concerned about taking on debt as a small business owner? As a result of COVID-19, small businesses in Canada have taken on an average of $135,000 in debt. On one hand, financing your business through debt is often perceived as a method of last resort. This is because small business owners fear becoming stuck in a cycle of repaying debt. On the other hand, debt can also be used as a tool to operate and grow your small business.
From working mom to entrepreneur
For example, a client of ACCESS Capital Community Fund is a working mother of two who lives in the Greater Toronto Area. In the past, she struggled financially and had a poor credit score. As her kids were growing up, she found herself constantly buying new clothes that would fit them. As a budding entrepreneur, she thought of a business idea to sell affordable children’s clothing to lower-income families.
She applied for a business loan from the traditional banks and was turned down. Feeling rejected, she gave up hope in her dream of starting a business. A few weeks later, she was talking about her business idea with a friend, who had received coaching from ACCESS Community Capital Fund. Encouraged by her friend, she applied for a small business loan at ACCESS.
The team at ACCESS interviewed her and was impressed by her passion and character, which is a key consideration for loan approval. Unfortunately, her business plan needed more details and she was not immediately approved. ACCESS set her up with a coach who helped her develop a business plan and financial analyses. After successfully re-pitching her business, she received a small business loan of $5,000 on a 36-month term that allowed her to buy inventory and advertise her kids’ clothing line.
Using debt as a business strategy
Debt Financing is an effective way to manage your business operations. For example, you can use debt towards both buying inventory and equipment for your business. Examples of debt financing include bank loans, personal loans, government-backed loans, lines of credit, and credit cards. Before applying for a loan, make sure you understand financing concepts including interest rate, compounding effect and loan repayment.
How do interest rates work?
The interest rate on a loan is a percentage amount charged on the principal sum (i.e. money lent) by a financial institution. The lender charges this percentage to account for the risk of lending the money. You must make regular payments that cover the interest charged and reduce the principal amount. Not doing so will lead to the compounding effect, which means an accumulation of interest charges resulting in rapidly increasing debt.
What if I miss a payment?
When borrowing you must have a plan to repay the loan. Defaulting on a loan can lead to significant penalties such as loss of collateral assets, a hit to your credit score, and difficulty obtaining a loan in the future. Understanding your repayment terms is essential. Repayment terms can vary but typically small businesses choose to repay monthly (standard repayment). Other options may include extended repayment, graduated repayment, or income-based repayment.
Make debt part of your business plan
Before applying for a small business loan, prepare a business plan that includes detailed financial analyses and projections. Also, choose a financial institution that appreciates your business idea and offers lower interest rates and manageable repayment terms. Remember that debt can be used as a tool to grow your small business, especially with the right plan and terms.
Opportunities at ACCESS
ACCESS helps individuals facing financial barriers in the Greater Toronto and Hamilton Area to obtain low-interest loans of up to $5,000 for small businesses. Financial barriers may include; low-income, poor or limited credit history and lack of collateral assets. Throughout the application process and after receiving the loans, clients receive consultation, coaching and resources. ACCESS guarantees the loans which are then disbursed and administered through our financial partners, Alterna Savings, for terms ranging from 12 to 48 months. Are you ready to start your small business? Learn more about our loans today.