Achieving significant business growth almost always requires external capital. In some circles, the best growth models involve equity investing, getting some investors to put money into your company and expecting an exponential return.
While equity financing often grabs headlines, it isn't always practical or preferable, especially for small to midsize transportation companies. Debt financing is another option, leveraging existing assets while maintaining ownership and control.
Debt financing involves borrowing funds to be repaid over time, often secured by business assets such as accounts receivable, inventory or equipment. Asset-based lending (ABL) applies particularly to companies with substantial assets but evolving cash flow needs.
Pros of debt financing
- Ownership Retention: Business owners retain complete control and decision-making authority without giving up equity.
- Tax Advantages: Interest payments on debt are often tax-deductible.
- Predictability: Structured repayment schedules make it easier to plan and manage cash flows.
- Scalability: Many credit lines grow alongside your receivables or inventory, providing dynamic access to more capital as you expand.
Cons of debt financing
- Fixed Repayments: Debt obligations must be met regardless of business performance, which can pressure cash flow during lean periods.
- Risk of Over-Leverage: Excessive debt can strain balance sheets, potentially limiting future borrowing or investment opportunities.
- Collateral Requirements: Borrowers must pledge assets, and in some cases, personal guarantees may be required.
- Covenants: Lenders will typically require loan covenants tied to the financial performance of the company.
How companies leverage debt effectively
There are several ways to use debt. Debt is an effective tool for building inventory. Many smaller companies can only afford to place small inventory orders with their available resources. Instead, they can use debt to purchase additional inventory, enabling them to fulfill more orders at a better cost.
Another area where that money could be invested is capital expenditures, such as machinery, to improve automation and efficiency. For example, a small manufacturer of high-end wedding bands faced significant material waste cutting valuable meteorite fragments. Using a loan, the company invested in a precision cutter that dramatically reduced waste. Within a year, this machinery not only paid for itself but also doubled the usable material from each meteorite, significantly boosting profit margins. The owner described it as the best investment they'd ever made. In the trucking industry, most capital expenditures are focused on trucks, equipment and warehouses to support the transportation of goods.
Companies can allocate funding to boost their marketing budgets. One customer used debt to double their marketing budget by running pre-roll ads on streaming services. With this new spending, they found that for every $1 spent on marketing, they earned $3 in return. They applied the funds to enhance and expand their brand.
Managing the risks of debt financing
The primary concern with debt financing is the risk of becoming overleveraged when the economy slows. Transitioning from a growing economy to a shrinking one affects almost every business, resulting in reduced cash flow. Here are some steps to effectively use debt financing:
- Clearly define your growth objectives.
- Assess your current assets and choose the right financing method.
- Structure debt around predictable cash flows.
- Regularly monitor your financial ratios and adjust as needed.
- Maintain regular consultations with your banker or financial advisor.
Debt, no debt or venture capital funding
Some individuals have a strong aversion to debt. Often, this feeling comes from a lack of understanding of how to leverage it effectively. While debt can be bad if used improperly, it can also be a valuable tool for business growth when managed correctly.
Equity financing entails raising capital by selling ownership stakes in the company, whether through friends and family, private investors, venture capital or public offerings. For businesses that want to minimize debt or need a major infusion of cash for high-risk, high-reward initiatives, equity can be an attractive option.
Pros of equity financing
- No Immediate Repayment: Unlike debt, there are no fixed repayments, reducing the strain on early cash flows.
- Shared Risk: Investors assume risk alongside the company and are vested in its success.
- Strategic Partners: Equity investors often bring valuable business expertise, networks and market credibility that can accelerate growth.
Cons of equity financing
- Ownership Dilution: Founders and early stakeholders must relinquish a portion of ownership, reducing their control and future returns.
- Potential for Conflicts: New stakeholders may push for decisions that serve their interests but may not align with the company’s original vision.
- Higher Long-Term Cost: Giving up ownership today can be much more expensive over time if the company’s valuation grows significantly.
For many companies, relying solely on equity financing is not ideal. It can create unnecessary dilution and lead to less control over the business’s future direction.
Balancing debt and equity
The most resilient and high-performing businesses find a good balance between debt and equity, creating a capital structure that:
- Provides sufficient liquidity to invest in growth initiatives.
- Protects ownership and strategic decision-making for key stakeholders.
- Maintains flexibility to adapt to changing market conditions.
- Optimizes cost of capital, ensuring that financing supports profitability rather than eroding it.
Finding this balance is not a one-time decision—it requires ongoing assessment as the company grows, markets shift and new opportunities arise.
Don’t go it alone, whether you opt for debt or equity. Work with your banker or financial advisor to determine the best path for your company’s growth, considering your industry and the national economy today and in the future. Also, prepare for any downsides if the situation changes. Debt doesn’t have to be scary if you manage and monitor it well. It can be an excellent growth strategy.
