Small and medium-sized businesses (SMBs) that take on debt actually perform better than those that don’t, according to a new report, though analysts warned that companies taking on personal loans rather than small business loans aren’t seeing the same benefits.
Reports in Forbes Monday (Feb. 19) said research from finance professors Rebel Cole at Florida Atlantic University and Tatyana Sokolyk at Brock University found a correlation between higher revenues and small business loans. The report said SMBs that took out a business loan reported nearly twice as much revenue after three years as SMBs without debt when they first began their operations.
In addition, researchers pointed out that the small businesses that financed their operations via personal loans — like home equity or personal credit cards — actually reported an average of 57 percent lower revenues after three years. SMB borrowers also have a 19 percent greater chance of surviving past their first three years than small firms with no debt, while companies that obtained personal finance of some kind only saw a “slightly” higher chance of survival past this period.
Further, analysts found a correlation between higher debt and failure rates, suggesting that while some business debt can help a company survive and thrive, too much can have the opposite effect.
Cole and Sokolyk have posited three reasons for the findings. First, entrepreneurs who are willing to take on the burden of obtaining a small business loan could be more serious about making their businesses succeed. Second, SMB borrowers must also have their companies vetted by lenders, so those that obtain financing are deemed healthy to repay the loan.
“If you’re able to get a loan in the name of the business, then the bank is actually taking a look at the business,” Cole said, adding that a third possible factor is that financiers often monitor the health of businesses that have borrowed money, and provide mentoring and other services to help the company along.
As for why personal debt seems to correlate with worse business performance, Cole has a theory.
“If a firm is borrowing in the name of the owner at a startup, then it has used up at least some of that debt capacity, whereas a firm that does not borrow in the name of the owner retains that debt capacity to use in subsequent years if needed,” he said. “The firm is capital-constrained from the beginning and must spend less on investments that produce future revenues.”