I RECENTLY read an interesting, albeit one-sided article about the downside of using debt funding for your business or project.

The author lamented the unforgiving attitude of South African funders to defaulters, and the potentially disastrous consequence for the business but also for the estate of the owner or guarantor of the funding — of perfection of the funder’s rights in the event of irreparable default.

The author advised small business owners, if debt funding was unavoidable, to consider structuring their business and estate so their personal assets were protected from funders’ claims.

He said this knowledge had been hard won by personal experience. This left me dissatisfied.

In running and growing one’s own business, the need for debt funding is typically as much a reality as the need for sales or margins. It is often not an option.

Similarly, funders require security, making intentions of protecting personal or business assets from their claims irrelevant as one has to offer sufficient security to get the funding — which often means pledging everything.

Once it is established that debt funding is required to achieve business targets, there are several important issues to consider.

Quantum

Debt funding is expensive and difficult to repay, so take on as little as possible. Plan your business development carefully, and quantify your funding needs.

Remember two things: too much funding will mean unnecessary interest payments and a clear signal to your funders that you don’t really know what you’re doing.

Too little will mean you cannot achieve your goals. Going back a second time will really destroy your funder’s confidence in you.

Prepare a comprehensive and precise budget, allow for contingencies and stick to your budget.

Matching

It is important to match the type of funding you seek with the application of it. For instance, it is unwise to use overdraft or facility funding to buy fixed assets with an expected useful life of several years. The funding market has many products.

Sourcing

As recently as 10 years ago, sources of funding were far more limited than they are today. Fortunately, shopping around is now the norm, allowing you to find a source of funds suitable for your specific needs.

Security

Everything already said about security is true. But funders will seek as much as they can get. Once the security is pledged, it is not as attractive for use as security on additional funding.

Tying up all of your security on one specific tranche is a barrier to entry to any other funder, and can hamper growth.

Attitude

If one were to ask most funders why they take excessive security, the answer would be the high default rate.

All businesses go through tough times, making debt-servicing difficult. What is required is a dogged determination to service the debt.

But play open cards with your financiers, renegotiate openly if the situation becomes unmanageable. Foreclosure is always a funder’s last resort.

As a last note, I am happy to report that the author of that article says he has rebuilt the lost assets and is in an even better situation.

I wonder where he might have been had he not gone through the experience. Talk about the school of hard knocks!