Risks of Taking on Debt

Companies may hesitate to take on debt, concerned about the risks of debt investment. Debt — unlike equity — must be paid back when it comes due. Some loans even amortize, which means you have to make regular principal payments during the term as well as making a final payment at maturity. You have to make sure you’ll have the money available to service the debt as required.

Often, as the maturity date draws near, the company looks for opportunities to refinance the debt, rather than have to come up with the full principal amount. There is a risk that other lenders won’t be able to provide refinancing options at the time the company needs them. It helps to have a plan and to prepare early for this eventuality.

Debt also may be accompanied by a security interest, depending on what kind of debt it is. This means the lender has a lien on the property of the business (and sometimes on the property of the owner, if the owner provides a guarantee that is secured). The risk here is significant. If you don’t pay back the debt — or if you go into default for some other reason — you risk losing the assets you provided as collateral, and often the entire business itself. The trade-off is that secured debt usually bears a much lower interest rate than unsecured debt, so your costs are much less.

As with any business decision, there are risks and rewards to consider when receiving a loan.

Susan Alker is a California attorney with over 20 years of experience advising lenders and commercial borrowers.

Categories: Debt