“Neither a borrower nor a lender be,” cautioned Polonius in “Hamlet.” William Shakespeare’s advice has gone on to form an attitude about debt that has survived countless generations.
Most insurance professionals are financially conservative by nature, and their attitudes toward borrowing often spill over into their businesses. They avoid debt in their personal lives and do their best to steer clear of it in their professional life as well.
There is unquestionably some wisdom in avoiding debt, particularly for individuals. One of the first financial lessons most people learn is to live within their means. Taking on more debt than we can afford to repay can easily push us into a situation that spirals out of control.
Different for businesses
But debt plays different roles for individuals and businesses. In fact, when it comes to business borrowing, “debt” isn’t the most accurate term. A better choice is “leverage,” because that describes the role borrowing can play in your insurance agency. Essentially, when your agency borrows, you’re leveraging other people’s money to achieve a purpose that will increase your wealth and/or the value of the business. 1
In fact, the idea of borrowing is so negative to many business owners, that they make a big mistake in an effort to avoid it. When they need extra capital, instead of taking on temporary debt, they permanently give up part of their equity by assuming partners or equity investors. When you sell equity, you’re giving someone else the opportunity to profit from the hard work you’ve already put into the business, and you’re taking on what Kevin O’Leary describes as “a permanent partner that will bother you for the rest of your business’ life.” 2
Some business owners believe a more sensible approach to business is a reliance on organic growth that doesn’t involve borrowing. On the surface, that may seem like a better solution, but pursuing organic growth forces you to reinvest profits that you would otherwise be taking out of the business as income. It takes more time to achieve, and it essentially forces you to accept a smaller return on your personal investment in exchange for the eventual growth of the business. Careful borrowing, on the other hand, gives you the opportunity to simultaneously increase your business’s profits and your overall return. 3
Debt can be healthy
When you use debt instead of granting equity, you don’t lose any control of your agency. As long as you repay the loan on time, you know exactly what your borrowing costs will be, and once you make the final payment, the loan disappears for good. You’re left to run your agency the way you want. 4
In addition, you may be able to deduct both the interest and the principal on the loan from your business taxes, making debt even more affordable. However, be sure to verify deductibility with your CPA or other tax preparer before you borrow. 5
When does it make sense?
It’s important to think of debt as a strategic tool. You can use tools such as lines of credit to help you with shorter-term needs such as managing cash flow. There should be a specific purpose for your decision to obtain financing, whether that’s to buy upgraded technology, build a new office, or acquire another agency or book of business. Before deciding to borrow, create a business plan explaining your objectives and the return on investment that you anticipate receiving. Be conservative when estimating — understate expected revenues and overstate your costs — so that any surprises are pleasant ones.
If the expected return on investment is significantly higher than what it will cost you to borrow, taking on debt may be strategically wise. However, you should always stress-test your plan. In other words, consider whether you’ll be able to meet your obligations if, for example, your profits don’t match your expectations. 6
As an insurance professional, you know that every reward carries corresponding risks, and the use of debt is no exception. The advantages of using debt to grow your agency are offset to some degree by several points. The biggest is that you’ll be expected to repay what you owe, even if something happens to your agency. In some cases, you’ll be expected to back your loan with a personal guarantee, so that if the lender can’t collect from your business, it can chase your personal assets. And, if the lender requires collateral, borrowing may place some of your business assets at risk. In addition, if you file bankruptcy, the lender will get first crack at any assets that remain.
Depending on the market, the lender, your agency’s financial health, and your own personal credit history, you may have to pay a higher-than-normal interest rate. The more you borrow, the higher that rate is likely to go. 7
Finally, if your agency becomes heavily dependent upon debt, it might be viewed as risky at some point in the future when you’re courting a buyer or partner. 8
The financing to support your growth
Once you’ve made the decision to expand and transform your insurance agency, you’ll probably need to invest some additional capital in your business.
Where should you go? Often, agency owners turn to a familiar source: a bank officer. However, most traditional banks aren’t comfortable with the financial structure of insurance agencies. Most are geared to making loans to businesses that have tangible assets such as inventory, equipment, and real estate. Another option is loans that are guaranteed by the Small Business Administration, but SBA loans typically take a long time to process, may involve an overwhelming amount of paperwork, and have relatively small lending limits.
That’s why a growing number of insurance agency owners are turning to specialty lenders that are accustomed to working with the confines of the insurance industry. Such lenders understand how an agency like yours operates, and are familiar with the nature of your income streams, so they can approach the underwriting with realistic expectations and an appreciation for inherent risks.
Are you ready to strategically take your agency to the next level?
1 “When Debt is Good,” Investment Advisor, July 3, 2017.
2 O’Leary, Kevin, “3 Ways to Grow Your Cash Flow With Debt,” inc.com, April 7, 2016.
3 Scott, Mark, “Debt is a cheaper way to grow your business,” sbnonline.com, January 1, 2017.
4 Allen, Scott, “Debt Financing: Pros and Cons,” thebalance.com, March 20, 2017.
5 Kunigis, Allan, “How to Finance Your Business Growth,” thehartford.com, undated.
6 Scott, ibid.
7 Allen, ibid.
8 Kunigis, ibid.
9 Schreter, Susan, “Taking on Debt to Grow Your Business,” entrepreneur.com, undated.