When Should Your Business Borrow Money?

Most businesses will run into financial trouble at some point in time, whether that’s in the initial phases of seeking funding, or hitting a cash flow wall in the middle stages of growth. Ideally, your company would generate enough revenue on a consistent basis to cover these problematic patches, but there will be extenuating circumstances that prevent that from happening.

Borrowing money is probably the first option you consider when addressing this issue, but it isn’t appropriate in all situations.

The Options

Borrowing money from a lending institution is fairly straightforward, though you’ll have your choice of several options. You can pursue a business loan, or if your business doesn’t have much history, a personal loan. Beyond that, there are many loan types, including a business line of credit which you can draw upon and pay off regularly (like a credit card), and a balloon loan, where you’ll pay only interest until the end of the agreement, when you’ll pay the principal in full.

If borrowing money isn’t an ideal option, you do have other potential choices:

• Fishing for investment capital. Here, you’ll woo venture capitalists and/or angel investors for the extra capital you need—but you might have to forfeit part of your ownership in the process.

• Crowdfunding. Crowdfunding is a decent option, but only if you have something truly original and desired for your participants.

• Tapping into personal savings. If you have a pocket of personal savings, you can consider tapping into it—but this is usually an option of last resort.

Most Appropriate Situations for Borrowing Money

So when is it most appropriate to borrow money as a business?

• Investing in a feature that will bring new business. If you’re making an investment in a feature you’ve researched, and know will bring new business, it’s usually worth pulling the trigger. For example, a vestibule for a restaurant in a busy city could greatly increase curb appeal and visibility, drawing in new foot traffic. Though estimates are hard to make with pinpoint accuracy, you should be able to roughly calculate whether the new investment will pay for itself in the near future. If it does, the temporary burden of loan payments and the additional money you’ll spend on interest should be worth it.

• Overcoming a temporary shortfall. You may also want to borrow money if you know a situation is going to pose a temporary burden on your finances. For example, if you’re hiring temporary workers for the busy season, the extra salaries will put extra stress on your cash flow—but once the busy season starts, you should be able to make up for that extra expenditure. A loan can help you close that gap without significant risks to you or your business.

• Investing in necessary infrastructure and repairs. Infrastructural upgrades and repairs are almost always worth making, especially if you work in an industry with high standards or demanding regulations, such as food processing. Making repairs and upgrades now, rather than later, may end up saving you money (as most problems get worse over time), so it’s worth taking out the loan to take advantage of that cheaper price.

• Maintaining company ownership. Some other options, including venture capital fundraising (and sometimes crowdfunding), will necessarily dilute your ownership in the company. That means you’ll collect fewer profits and will be forced to share decision-making responsibilities (at least in some cases). If you’re in desperate need of capital and you aren’t willing to make that sacrifice, a loan is probably your best option.

• Recovering from an unexpected loss. Unexpected losses, such as equipment damaged in an incident that isn’t covered by insurance, or the loss of a major client, could also be grounds for borrowing money. These losses don’t usually reflect your overall potential as a business, and are often temporary. A loan can help you recover from them quickly, while setting yourself up for a better position later on.

Obviously, managing business financials is complex, and difficult to reduce down to a handful of bulleted recommendations. If any of the above criteria apply to your situation, it should push you closer toward the decision to invest—but that doesn’t mean they’re the only criteria that matter, or that you definitely should borrow money if they apply to you. Learn what you can about the borrowing process, and only make the decision when you feel you have all the information.