One of the questions that often comes up when discussing finances among event professionals is: Should I take on debt to finance a business?
Only in the rarest of circumstances would I recommend that course of action. Loans, credit cards and lines of credit should only be used when the owner has a strong strategic vision on how that risk is going to bring strong returns. In most circumstances, I see the opposite. Business owners take on debt without thinking of the long-term impact of that decision.
Why is debt so bad? Because it sucks up cash. A business might be profitable and perform well, but if it is deep in debt, the owners must satisfy that obligation before they see any profits.
If the debt payment is $1,000 per month, that’s $1,000 per month in profits that the owner will never see until that debt is satisfied.
Not only can debt limit earnings available for the owner to draw upon, but also other investments: inventory, a new website, additional staff, and so on.
And, because the event business model is service-based, the owner will have to do an increased volume of events to satisfy debt obligations and maintain business as usual. This often creates a never-ending treadmill for the business owner.
The following are three mistakes business owners make when taking on debt.
1. Debt is secured to finance a poor financial model.
Most often, I see business owners securing debt to finance a poor business model. If your business isn’t profitable, debt isn’t going to fix the problem. Debt just makes the problem worse.
If you can’t pay your bills or if you aren’t earning enough, reexamine your pricing and your costs. Reexamine your marketing strategy. Event businesses that are struggling financially don’t have enough profit margin, or simply aren’t selling enough volume. Fix your margin problem and/or your sales problem, and you’ll fix your financial issues.
2. Debt is secured with zero repayment strategy.
Debt should only be acquired if the money will be used towards making an investment that will help the business grow exponentially.
For example, an investment in rentable assets might give a rental company the ability to double its sales. (If you invest $50,000, I’d like to see that your sales increase by $100,000–not only to satisfy that debt obligation, but also to create a return for the business.)
In this case, the additional sales might help the business pay down its debt and have more profits. Investments like this can make sense. You want the loan or credit to help the business exponentially.
3. Lines of credit are used permanently.
Too often, I see a business owner lean on a line of credit that becomes a permanent crutch.
A line of credit is supposed to help a business get through seasonal highs and lows. A line of credit is ideal for a retail business owner that needs to place a $50,000 apparel order in January for summer goods. Those summer goods would bring $100,000 in sales six months later. The line of credit is supposed to help the owner bridge the gap with upfront investments.
This type of upfront seasonal investment doesn’t typically happen in the event industry, unless product is being sold. Most businesses receive deposits upfront, which should be used to make those product purchases. I see business owners in the events industry use the line of credit to cover overhead during the slow event season.
Often a business is having challenges covering that overhead year-round--and that line of credit becomes a permanent balance that never gets paid down.
If you dig deeper, you’d likely see that this business has a hard time covering its expenses (and it’s not just a seasonal catch-up single occurrence). This relates to the first point: The business has a weak financial model.
In summary, if you’re feeling tapped financially, debt can only make the problem worse. If you do have a large investment you want to make, and taking debt is the only option for financing, then make sure you have a strong ROI strategy and repayment plan. I like building out a cash flow plan to chart it all out. This helps me test whether the investment, and the repayment strategy make sense. Doing otherwise can land a small business in a lot of hot water.
Michelle Loretta is a business consultant and financial strategist for wedding and event professionals. As founder of Sage Wedding Pros, she blends her past as an accountant for Deloitte, a sales and marketing manager for DDLA, a merchandiser for Coach, and a stationery entrepreneur to strengthen wedding businesses worldwide, including offering her Financial Strategies and Cash Flow Plans for Event Businesses. She has been asked to speak at industry conferences, including The Special Event and NACE Experience.