Opinions expressed by Entrepreneur contributors are their own.
The average small business owner today has nearly $200,000 in debt. While financial leverage is often an essential way to grow a small or medium-sized business, you need to be careful about how much debt you take on.
As CEO of Wealth Stack, a company specializing in helping veteran business owners build an optimal capital structure and access the right kind of capital, I see CEOs and CFOs increasing their debt ratios without rhyme or reason.
As part of my one-on-one with select CEOs, I often outline a series of questions that can help business owners determine how much debt they should take on. Typically, this looks like asking yourself, “Do we have enough insight into our tax situation to be confident about the after-tax cost of debt? What are our strategic goals, and how might debt constrain our ability to achieve them? How much debt can we comfortably service without putting strain on our cash flow?”
By considering these factors, companies can create a debt ratio that is both sustainable and advantageous. However, there’s more nuance to taking on millions of dollars of debt than that. Here’s how you can determine how much debt and what kind of debt you should take out.
Related: 4 Scenarios When It Makes Good Sense to Take on Business Debt
The importance of financial leverage
In simple terms, financial leverage is the use of borrowed funds to increase returns on investment. The main advantage of financial leveraging is that it allows you to control more assets than you could otherwise afford, thus potentially earning higher returns. It can, however, amplify the effects of good investment decisions and weaken the effects of bad ones.
In worst-case scenarios, poor management of financial leverage leads to large amounts of debt that may become difficult or impossible to service. Thus, financial leveraging should only be used after careful consideration.
In this context, it’s important to carefully consider not only how much debt you should take out to grow your business but also what kind of debt makes the most sense. Before we dive into this, though, it’s important to ensure you understand what a debt ratio is.
Debt ratios for asset-intensive businesses
A debt ratio is a financial metric that calculates the relationship between a company’s total debt and its total assets. In general, the debt ratio for a medium-sized business should be below one, which indicates that the company has more assets than debt.
It is important to keep in mind that a high debt ratio can put a strain on cash flow and make it difficult to obtain new financing. As a result, companies with high debt ratios should carefully monitor their financial health and take steps to reduce their debt levels if necessary.
Related: 8 Things Entrepreneurs Should Look for When Getting a Business Loan
The coverage ratio of two times
Businesses should also have a debt threshold, which is the maximum amount of debt that they can comfortably carry. For many businesses, their debt threshold is reached at a coverage ratio of two times or higher. The coverage ratio is a measure of a company’s ability to make debt payments. It is calculated by dividing a company’s earnings before interest, taxes, depreciation and amortization (EBITDA) by its total debt payments (principal and interest). A company with a high coverage ratio is less likely to default on its debt payments than a company with a lower coverage ratio.
Factors to consider when determining debt threshold
When determining the debt threshold for your company, the most important factor is the company’s ability to service the debt. The company must have enough cash flow to make the required debt payments.
Additionally, the company should have a good track record of making debt payments on time. Another important factor to consider is the company’s creditworthiness. This includes both the credit score and the financial history of the company. Lenders will want to see that the company has a history of responsible financial management before they will extend credit.
Finally, it is also important to consider market conditions when determining the debt threshold for your company. If interest rates are high or economic conditions are weak, it may be best to limit debt levels to avoid financial difficulties. Aside from these basic factors, we urge all companies that work with Wealth Stack to consider these additional factors.
Related: The Most Common (and Preventable) Mistakes Small Businesses Make — and How to Avoid Them
What is your current cash flow?
When your business is growing, it can be tempting to take on more debt to finance expansion. However, it’s important to consider your current cash flow before making any decisions. If your cash flow is already stretched thin, taking on more debt could put you over your debt threshold and put your business at risk.
Instead, consider using other financing options like selling a portion of the business. These options can provide the capital you need without putting your business in a precarious financial position.
Organic growth is the internal growth of your company through factors such as sales and revenue. This is in contrast to growth that is achieved through outside means, such as acquiring another company or taking on new investments. When considering whether or not to take out more business debt, it’s important to consider your company’s organic growth.
Ask yourself the following question: Is growth inherent to the company or are we barely making it now? If your organic growth is strong, it likely means that your company is doing well and can handle additional debt. However, if organic growth is weak, taking on more debt may put your company at risk of defaulting on its loans.
Mergers and acquisitions can be a smart way to increase the scale and profitability of a business. Financing your business with debt in this way is a great way to turbocharge value creation in exchange for equity. This comes with the risks and requirements for discipline that debt necessitates. With synergies, sometimes one plus one does equal three. You can use that EBITDA to pay off the debt in two years.
Related: The 5 Cs to Consider When Applying for a Business Loan
Project forward what your ability to repay this debt will look like over the life of the loan. Then, consider what are the patterns in your current cash flow and projected profits. What changes are you expecting to see based on your current cash flow patterns and business growth? For example, are you organically growing every year based on these patterns?
Look at amortization schedules
Some loans don’t need to be paid back until the end, but other loans require that you pay them back based on a business trigger (reaching a certain level of cash flow, for example).
Regardless of the amortization schedule, it’s best if your coverage ratio stays above two times.
In conclusion, while financial leverage can be a useful tool for small and medium-sized businesses to grow, it’s important to be mindful of the amount of debt taken on. Business owners should consider factors such as their tax situation, strategic goals and ability to service the debt without putting strain on their cash flow when determining the appropriate debt ratio.
Companies should also keep a debt threshold and consider factors such as their ability to service the debt, creditworthiness and market conditions when determining this threshold. By considering these factors, businesses can create a debt ratio that will last — and help you thrive.
Your Company’s Responsible Guide to Staying Profitable in a Recession
Opinions expressed by Entrepreneur contributors are their own.
The recent trend of easy money and exorbitant valuations has skidded to a halt amid recent economic volatility. Understandably, many companies rode that wave as long as they could, but in doing so many prioritized growth over sustainability and sound leadership. Layoffs continue to ripple through the tech ecosystem, so employees both in this sector and elsewhere are feeling the consequences.
Having to let go of staff members is all but unavoidable in a company’s lifecycle, but there is always more that can be done to keep businesses afloat while preserving morale. Strategies can include responsible budgetary decision-making, thoughtful and prudent responses to external pressures and transparent dialogue with employees, to name a few. Such actions can help companies remain healthy, productive and profitable, even as they navigate challenging waters.
This is What You Need in Your 5-Year Marketing Plan
Opinions expressed by Entrepreneur contributors are their own.
We’ve all heard the interview question, “Where do you see yourself in five years?” Marketers routinely take that question and apply it to their marketing strategies. They figure out what they want to achieve and then develop actionable steps to get there. Keep in mind, these plans aren’t designed to be all-encompassing. They serve as a guidebook for different scenarios while getting the team thinking about what they’d like to accomplish long-term.
Your five-year plan is a way to build an overarching metric for how you’re doing — or how you plan to do over the next half-decade. There are many things to consider when building your plan — here are a few to look at carefully:
The 3 key buckets
A successful five-year marketing plan should fixate on three main questions:
- What assumptions can you make about the next five years within your company?
- What goals do you want to achieve?
- What are the metrics you’ll use to measure those goals?
Assumptions are what you think won’t change in the business over the next five years. For example, you might assume that you will continue using particular vendors or that packaging costs will remain stable. From there, you can determine your goals — like boosting sales by 50% or converting 10,000 new customers. The metrics that measure your progress might be units sold or your company’s market share. It’s essential to include both readily-accessible metrics — such as website views — and brand metrics that might be a bit harder to come by, such as the associations your customers have made with your products or company.
Importantly, there’s no “right” or “wrong” when it comes to answering these questions. Every business has its own vision, resources and position, which all influence its marketing strategy. The aim is to develop a plan that will produce the most desirable outcome for you, rather than worrying about what other businesses have the capacity to do.
Related: Use These 5 Steps to Create a Marketing Plan
Narrowing your focus
Just like consumer preferences, marketing tactics are constantly shifting. Social media demonstrates this well. Because social media platforms have skyrocketed over the past two decades, marketers no longer rely solely on traditional platforms such as print or television ads. And even within social media, things aren’t constant. TikTok has become one of the fastest-growing platforms, quickly overtaking Facebook.
With so many options, your marketing plan must keep a narrow focus. For some companies, TikTok doesn’t matter. They can’t yet measure the return they’re getting from the platform, so this isn’t exactly a feasible opportunity. Don’t be tempted to try everything or be everywhere. It’s a matter of isolating what you practically can use to give you the insights that will help you.
Two questions will help focus your strategy:
- How do your goals compare to last year?
- What are you striving for (e.g., enhancing the brand vs. increasing brand awareness)?
How you answer those questions will help you identify where and how to focus your efforts so you don’t get lost in a bunch of small, irrelevant tactics.
Using your budget
Most people think of budgets as being stable or hard data — but almost all companies work with unknowns. In reality, the best they can do is come up with an educated guess that seems to make sense – a ballpark range. Because nobody can plan with certainty for every scenario — and because it’s so easy to become overwhelmed with an infinite range of outcomes — it’s advisable to lean on a few key financial assumptions and build a strategy around those.
Once you have a budget figure to work with, create high and low projections for everything you want to do. Let’s say the aim is to get to 50% brand awareness. What would your plan look like if you exceeded that and got to 75%? Alternatively, what would you do if awareness went down to 25%? Creating these high and low projections will let you design a more flexible approach and avoid being caught too off guard.
As you come up with your main scenarios and high-low projections, think about the key internal drivers you’ll need to address next year. Consider the risks, and assess whether you’ll have the data, technology and skills to develop and maintain what you expect to put forward. Keep in mind that it’s more important to pivot when issues come up than to predict what’s going to happen accurately.
Related: 4 Tips for Developing a Marketing Plan That Will Actually Grow Your Business
Paint flexibly within your broad strokes
A five-year marketing plan paints a broad, long-term picture of how you’ll communicate with your audience while giving details about your projected products or services. It includes assumptions and factors that aren’t necessarily static, so you have to approach it with a grain of salt and be ready to shift gears if the plan doesn’t work.
Even so, if you stick to three key buckets (assumptions, goals and metrics), keep your tactical focus narrow and incorporate multiple projections in your budget, you should end up with a strategy that blends the data and flexibility needed to strive in a changing world. Because annual marketing plans need to connect to your long-term marketing vision, let the annual marketing meetings serve as check-in points to keep your longer-term marketing plan relevant and viable.
Lauren Sánchez Is Heading to Space on a Girls Trip
Sorry, Jeff — this one is for the girls.
Jeff Bezos’ girlfriend, Lauren Sánchez, said in a new interview with the Wall Street Journal that she planned to take an all-female trip to space with the Amazon founder’s space manufacturing company, Blue Origin.
Five women will join her on the journey.
“It’s going to be women who are making a difference in the world and who are impactful and have a message to send,” she told the outlet.
The mission is set for early 2024, and the passengers’ names will be announced at a later date.
The WSJ’s report was Sánchez’s first solo interview, the outlet noted, since her relationship with Bezos went public in 2019, shortly after his divorce announcement from now ex-wife, MacKenzie Scott.
The interview also talks about Sánchez’s relationship with Bezos and the business advice he’s given her (keeping meetings under an hour, speaking last as a boss).
Sánchez is a former broadcast journalist and a helicopter pilot who founded her own filming company Black Ops Aviation, per Insider.
“Right now, I’m immersing myself in philanthropy and strategic giving,” she told the outlet. She also has a new production company, Adventure & Fellowship.
Bezos and Sánchez also work together on picking the winner for the Bezos Award for Courage & Civility, which was awarded to Dolly Parton in 2022, giving her $100 million to dole out to charities as she pleased.
But don’t expect Bezos to crash the girls’ trip. “He’ll be cheering us all on from the sidelines,” Sánchez said, adding that Bezos is “excited to make this happen with all of these women… He’s very encouraging and excited, and he’s thrilled we’re putting this group together.”
Sánchez’s nonprofit work includes This Is About Humanity, which helps give supplies to kids separated from their parents at the U.S.-Mexico border, supporting the Bezos Earth Fund, which fights climate change, and working with the Bezos Academy, a system of free Montessori schools.
Bezos told CNN in an exclusive that aired in mid-November that, like many other billionaires have pledged to do, he would give away most of his money.
Ex-wife Scott, meanwhile, has donated over $14 billion since 2019, much of it coming from the settlement with Bezos.
Bezos has always planned on giving his money away, Sánchez told the outlet.
“Jeff has always told me since I’ve known him that he’s going to give the majority of his money to philanthropy,” she said.
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