How Debt Is Used as a Strategic Tool for Growth
If you would like to expand or transform your insurance business, you will likely need to invest additional capital — debt and/or equity. This could mean borrowing, which means taking on debt. However, most insurance professionals are conservative by nature, and their attitudes toward borrowing often spill over into their business lives.
There is some wisdom in avoiding debt, particularly for individuals. One of the first financial lessons most people learn is to live within their means. However, when it comes to business borrowing, “debt” is not the most accurate term. A better choice is “leverage,” because it describes the role borrowing can play. When your insurance business borrows, you are leveraging other people’s money to achieve a purpose that will increase your business’s value.
When the idea of borrowing is unappealing, insurance businesses may often look to another option for extra capital: equity financing. Equity financing consists of giving up part of the ownership in the business by assuming new partners or selling shares to new investors.
As with most things, there are pros and cons to using debt or leveraging and equity financing.
Debt vs. Equity
When you decide to secure financing for your business, you need to determine whether equity or debt financing is the best fit. The biggest differences are ownership and control. With equity financing, the business exchanges a portion of existing equity or ownership for capital. Your position will be diluted, and you now have new partners and/or investors. When optimizing debt, ownership structure and control of operations remain in place, eliminating the risk of the business getting pushed in a direction you don’t want it to go.
Debt as a Strategic Tool
Once you have decided to optimize using debt to expand or transform your business, it is important to use that debt strategically. Before borrowing, create a strategic plan outlining the growth initiatives, reasons they are attainable and plans for reaching them to determine whether the return on investment warrants borrowing. Your plan should also include a budget to ensure adequate cash flow to cover all expenses, including loan repayment.
Next stress test — how will your business fare if your profits don’t meet your expectations? The time you invest into the planning process will help you determine whether borrowing is the right choice.
Options for Businesses
In addition to being strategic in planning for growth, it is important to be deliberate when considering financing options. For those who have little or no experience in commercial lending, local community banks are often the first lender considered. But banks are often hesitant to lend to insurance businesses because future commissions are the primary assets. Banks look for tangible collateral, such as equipment, inventory and real estate. As a result, insurance businesses frequently find it difficult to obtain bank financing without providing personal assets as collateral.
Another option is to apply for a loan guaranteed by the Small Business Administration. Historically, SBA loans take longer to process, involve a large amount of paperwork, have relatively small lending limits, can require a second lien on your home and a guarantee from your spouse.
An alternative is to explore cash-flow based lending through a specialty lender who understands your business and is accustomed to working within the confines of the insurance industry. A specialty lender will allow historical and projected cash flow from commissions to serve as collateral and take into account carrier ratings, contract rights, retention rates and loss ratios.
While taking on debt can be daunting, planning strategically, setting realistic expectations and carefully researching your funding options will put you on the path to successfully leveraging capital to grow or transform your business.
Finally, if your growth exceeds the cost of your debt, then use it.