Long-term debt does offer some financing advantages for businesses. If you don't want to give up some of your ownership to investors, you can use loans to finance growth. However, carrying a high level of long-term debt can present risks and financial challenges to your ability to thrive over time.
Cash Flow
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A major drawback of long-term debt is that it restricts your monthly cash flow in the near term. The higher your debt balances, the more you commit to paying on them each month. This means you have to use more of your monthly earnings to repay debt than to make new investments to grow. It also limits your ability to build up a safety net of cash savings to cover unexpected costs of doing business.
Stifles Growth
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Related to your limited free cash flow is more stagnant growth. To grow, your company needs the ability to invest earnings and extra money into new research and product developments, new buildings and equipment or other acquisitions. It is also more difficult to attract more customers because you don't have as much money to invest in marketing. This is where you communicate the benefits of your company and products to grow your customer base over time.
Collateral Risks
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Much of long-term debt is tied to collateral. You often have to use property as security to get financing, especially at reasonable interest rates. Building loans, for instance, are secured with your property as the collateral. If you fail to repay the debt, you could lose the property to the bank. The same issue arises with company cars and equipment. Once you start to lose assets through repossession, it becomes difficult to dig your way out of the financial mess.
Vulnerability
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Along with the potential for property loss, long-term debt leaves you vulnerable to the ebbs and flows of the marketplace. If your sales decline unexpectedly, it becomes difficult to cover your monthly labor and overhead costs while also making debt payments. If you start to miss payments, you incur late fees and hurt your business's credit. Plus, inability to keep up with current debt makes it hard to convince lenders to issue you new debt. At the extreme, you could face loan default and potentially bankruptcy.
