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By Ralph Jones
s founder and CEO of financial wellbeing company Blackbullion, Vivi Friedgut knows a lot about debt. And, like all CEOs, she has given considerable thought to when is it a good idea to take on debt.
“Debt is like any vehicle,” she says. “A car can get you from point A to point B or it can kill somebody and wrap you around a tree.”
Some of the biggest companies in the world are shouldering billions of pounds in debt. Take for example Ford with around £81 billion, Apple with around £80 billion, and Netflix with around £7 billion. Most companies need to take on some level of debt in order to speed up their growth.
But debt can be a daunting prospect: with the borrowing of money, or debt financing as it is known more technically, comes interest and uncertainty. Once the business has borrowed money, will its revenue dry up? Will it be able to keep up with the repayments? Will next year be worse than last?
Debt during a pandemic
This has been especially pertinent during the pandemic, which saw businesses scrabbling to be granted loans: between March and May 2020 alone, there was a 28% drop in revenue for small businesses. Barclays put aside more than £2 billion in case borrowers could not repay their debts. But its chief executive now believes that the UK is on course for the biggest economic boom since the end of the Second World War.
“You should always be wary about debt,” says Friedgut. “Always. Even if it's the right move, you should still go into it with your eyes open and read all the terms and conditions, which a surprising number of people do not do.”
Financial guidance is one of the things in which Blackbullion, a company that wants to make young people “money smart”, specialises. Educating people about debt means enabling people to understand that sometimes it is a wise, maybe even essential tool, and sometimes it is a dangerous, slippery slope.
Debt has a place in business, Friedgut says, but context is absolutely crucial.
‘Debt can be a wise, maybe even essential tool, and sometimes it is a dangerous, slippery slope.’
“I always see it through the lens of the opportunity costs of the money,” she says. Assuming someone will lend you the money, whether or not you take on debt will depend on what else you could be doing with your time – and how else you could be spending your money.
The government-backed loans that businesses took out – the Coronavirus Business Interruption Loan and the Bounce Back Loan Scheme – were good examples of when debt was the right decision: companies with severe cash-flow constraints would not have been attractive to investors, and the loans were available at extremely short notice.
Blackbullion is currently a growth business – a teenager, as Friedgut puts it – but two or three years ago, she explains, it had a cash-flow problem: there was more than £100,000 in outstanding invoices and the company had to pay rent. It therefore needed money quickly.
Friedgut had a number of calculations to make. One option at a company's disposal is invoice discounting: Blackbullion could have borrowed from a bank and used the invoices as collateral. Friedgut said that this didn't make sense at the time because the charge would have been comparatively high.
Another option was equity financing: selling chunks of the company to investors, who provide cash at the expense of a stake and some control in the business. (In January 2018 and May 2019 Blackbullion did exactly this, raising £945,000 in seed rounds – an amount of money that no bank would lend to a start-up.)
But carrying out an equity raise for the comparatively small amount of money Friedgut wanted at the time – around £45,000 – would not have made much sense, she says.
“That would be like getting a mortgage to buy your groceries,” she says.
For a start, it would have been harder, especially as a female founder (for every $1 of venture capital, two cents are given to women). But, more importantly, a round of fundraising takes six months on average.
This is one of the problems with companies running into financial difficulty, says Merlie Calvert, founder of Farillio, a company that supports businesses with legal services: people often realise they need to borrow money when it is too late.
Taking out a loan
But it was not too late for Blackbullion. Friedgut decided that it would borrow the money from the peer-to-peer lender Funding Circle, paying it back at around 6% interest over six months. It might have received lower interest rates from a bank but would not have been given the money as quickly. With Funding Circle, Blackbullion received the loan in a matter of hours.
A founder's biggest challenge, Friedgut says, is “time versus money”. The money enabled the company to “jump the chasm” between the amount it was owed and the amount it had at their disposal.
“It was a good use of debt, I believe,” says Friedgut. Another good use of debt (as opposed to equity) might be if your company finds itself temporarily unable to pay your staff.
“You certainly wouldn’t go to equity,” says Friedgut. “That would be a ridiculous reason to raise money. No one will give you that kind of money for that.”
“The reality is there no one-size-fits-all,” says Calvert.
She explains that business owners often opt for debt financing over equity financing for lots of reasons: they can still make their own decisions; they are not distracted by the interests of other people; and they don't lose the most qualified members of the company to lunches with potential investors.
And your business will probably seem like a safe bet to debt financing providers if you have predictable revenue steadily coming in each month and are either breaking even or making profit.
“The bigger the gap between break-even and profit, the better,” continues Calvert.
But there is a flip side, she says. She thinks that a lot of the information online about debt gives people false hope – by not mentioning, for example, that a bank will want to see that your business has stable revenue.
“A lot of the time, that ‘don’t pass go’ criteria isn’t made as clear as it could,” she says.
In other words, taking on debt – especially as a start-up – can be harder than it seems. The Start-Up Loans Company has been fantastic, she says, but wasn't an option for Farillio because it would have spent the lent money long before it launched.
If Farillio had borrowed money, Calvert says that it would have needed to be at least £600,000 and that she would not have been able to sleep at night if they had had to pay back a loan of that size.
Although Calvert has not taken on debt in the same way as Friedgut, she considered it last year because, as CEO, she says she needs to be open to all options. “At the moment, equity wins out,” Calvert says.
She is aware that through equity financing, each investor’s piece of the pie shrinks – a downside that is not applicable to debt financing. Last year, like many companies who did so through the Future Fund scheme, Farillio took convertible loan notes (a kind of short-term debt that is later converted to shares).
Here, the investors have to be happy with the risk – the loan doesn’t consolidate into ownership rights until further down the line – and some businesses may have constitutional documents that prevent them from easily issuing them.
Raising £750,000 through debt was both off-putting and impractical for Farillio: it would come with hefty repayments and “could end up holding us back as opposed to propelling us forward”, says Calvert.
But it would also have been too difficult to persuade a bank to lend them the money because banks look at how much a business made in its previous financial year. For a company such as Farillio, which is growing quickly, it will be impossible to qualify for the amount of money it needs.
‘Raising equity on a comparatively small amount of money would be like getting a mortgage to buy your groceries.’
Banks remain reticent
“It's completely understandable,” Calvert says about the banks’ reticence. “They don't take risks like venture capital funds and private equity houses will do. It’s why I think very few start-ups can even consider bank debt or debt generally, with any large degree of seriousness.”
The constitutional documents of some businesses may also prevent them from getting into debt. Or, if they allow it, the shareholders may not like lots of it – and may stipulate that money raised through equity cannot be used to pay off debt. In addition, some businesses will have obligations for their money: as soon as they make a profit, they may have to pay dividends, for example.
“What the bank won’t want to be is lining up behind other people,” says Calvert.
Friedgut is more than aware of these implications.
“The most important thing with debt is to know that you can repay it in a timely fashion, to make sure that you don't get into more financial distress,” she says.
There are situations in which Blackbullion would never consider debt: if, for example, it needed to raise £2 million to accelerate the business, or wanted to take their business to America, equity financing would be favourable: the sums of available money (with no interest) would be higher, and the right investor would come with the right expertise.
But Friedgut compares it to a mortgage: sometimes debt is necessary, and people should not shy away from it if they know they can repay the money.
“It's an important tool,” she says. “I'm a big believer in debt for the right reasons,”she adds.
Lead image: YILMAZ SAVAS KANDAG / Alamy Stock Photo
Debt has a place in business, but context is everything. Even if it's the right move for your start-up, go into it with your eyes open.
By Ralph Jones