We have often heard that debt is never good. Although people dealing in business have a different mindset. They see debt as a key to their success.

Now, what is a good debt in the business? Is there something called a bad debt? Well Yes, there’s both good and bad debt. Let's try to understand this with the help of some real examples.

In this blog, we talk about how debt could have saved a startup. We will spend time understanding what is good debt and how businesses can use it to grow exponentially. If you are a startup who is new to the world of business, then this blog is a must-read for you.

Before we move forward, a little about myself, I am Abhishek Patnaik, I have been consulting/leading a startup for more than 6+ years. At my company Surge Startup, we build products for companies and individuals. We have saved startups from their toughest product challenges.

Now let's get started.

Good debt is essentially an investment that has the potential to generate returns that exceed the cost of borrowing. It’s strategically using borrowed funds to create value or enhance an organization’s financial position.

Right back in 2019, when I was leading the technical aspect of a startup. The CEO made the mistake of selling his house to get his seed funded. We are in the 21st century, but sometimes our approach takes us back to the 19th century. Anyways, selling the house to seek initial investment is nothing but sheer foolishness.

The startup failed even after 4 years in the market. The best solution to this is to seek a loan. If the CEO had taken a loan against his house, he might have had enough time to repay the loan. Despite failing his startup, he had 10+ years of experience to secure a job and pay off his debts.

Good debt can be beneficial for several reasons:

1. Investing in Growth: A loan to expand operations, launch new products, or enter new markets can be considered good debt. For instance, you are borrowing money to build a new manufacturing facility that allows your company to produce more and increase revenue.

2. Capital Expenditures: Financing capital expenditures like new equipment or technology that will improve efficiency and productivity can be seen as a wise use of debt.

3. Tax Deductions: In some cases, the interest paid on business loans is tax-deductible, providing a financial advantage to the organization. One of the common tax deductions related to business debt is the interest deduction. Interest paid on business loans is often deductible from the taxable income of the company. This means that the business can reduce its taxable income by the amount of interest paid on loans during a given tax year. Mostly every developing country provides lots of facilities for businesses to take loans.

Example of Good Debt:
Let’s say you run a tech company, and you decide to take out a loan to invest in research and development for a cutting-edge product. If successful, this product could revolutionize the market, bringing in significant profits that far outweigh the initial loan amount and interest.

Bad Debt:
Bad debt, on the other hand, is incurred for non-productive or consumable purposes that do not generate long-term value or returns. It can be detrimental to an organization’s financial health due to the associated costs and potential negative impacts on cash flow.

As a CEO, when building a new feature, you may require additional employees and may need to take a loan to fund this expansion. However, if you fail to conduct thorough market research, the likelihood of your new feature failing is high.

Why Bad Debt Should be Avoided:
1. Interest Expense: Bad debt often comes with high-interest rates, leading to increased costs and reduced profitability.

2. Financial Strain: Constantly servicing bad debt can strain a company’s financial resources, limiting its ability to invest in growth opportunities.

3. Credit Risk: Accumulating bad debt can negatively impact a company’s credit rating, making it harder and more expensive to borrow in the future.

Example of Bad Debt:
Imagine a retail business that takes out a loan to finance a lavish office renovation that doesn’t contribute to increased sales or operational efficiency. The interest on this loan becomes an unnecessary financial burden, and the funds could have been better used for revenue-generating activities.

In summary, leveraging good debt can be a strategic move to fuel growth and create value, while bad debt should be avoided as it can lead to financial difficulties and hinder a company’s long-term success. It’s crucial for entrepreneurs to carefully evaluate the purpose and potential return on investment before taking on any debt.

At Surge Startup, we help companies build their software product and consult them to success. If you think there's a match between your requirements and our services then feel free to reach out to us at abhi@surgestartup.com or ping me at https://www.linkedin.com/in/abhishekpatnaik77/