Bad Debt: A Trap Entrepreneurs Should Avoid

October, 13 2019

As a new entrepreneur, it may be impossible to stay completely out of debt. The trick is to manage debt so it doesn’t become a trap that stifles your progress.

And don’t get me wrong, not all debt is bad. “Good debt” or “productive debt” can finance your business. The key is to focus the debt on accomplishing a specific business goal–one that’s needed to fuel your business and make you more competitive.

Bad debt, and its traps

Bad debt can take many forms. Any debt that isn’t well managed or comes from a dicey business decision is what I consider bad debt.

Here are a few examples:

  • Credit card rewards: If you’re putting purchases on the card for the rewards, you may be falling into a bad debt trap. I understand the temptation. We use the rewards for other business purchases like equipment and office supplies. But if you’re extending yourself for the rewards, it’s not worth it.
  • A new car: Entrepreneurs often transition from a regular job to going out on their own. It’s one thing to pay for a new car on your regular income. It’s another to pay for a new car AND finance your new business using your regular income. Don’t let those new car payments become a debt trap.
  • Tapping into your 401(k) or home equity line of credit: Loans from a 401(k) are low-interest and are tax-exempt. But all you are doing is borrowing from yourself and stifling your future retirement. A home equity line of credit also comes with low-interest rates. But, you must start monthly payments right away. Home ownership is very valuable. I wouldn’t risk that stability.

Habits for keeping debt under control

It’s always best to keep debt under control. To achieve this, advance planning is important. Here are tactics to follow if you want your business to grow and expand:

  • Minimize expenses as often as possible.
  • Hire employees you can afford when the business needs them. Do not hire in advance hoping you will need them later.
  • Avoid wasteful spending.
  • Maintain cash reserves for emergencies and downturns in the business.
  • Don’t strain the good/productive debt you have.

If your business needs help creating a business plan that will help you select and manage good debt, we are here to help. Contact us for a consultation.