The danger of debt in a downturn

 

I recently gave a webinar for the RISD Alumni Relations department called “Managing Your Creative Practice in a Crisis.” The video now is available on YouTube (embedded below).

One of the questions asked by a participant had to do with borrowing money to get through months of low revenue. This is a huge temptation, especially with the CARES Act offering all sorts of loans to small businesses to help them get through this crisis.

Deny the Debt Urge

I want to urge you to do everything you can to avoid using debt to fund yourself during a downturn. I did that after the 9/11 crisis, and while I did end up being able to pay it off, I could just as easily ended up being sunk by it. In hindsight, getting out of that mess was pure mercy, and had nothing to do with my business savvy or effective management.

As you evaluate your financial circumstances, if you see a big hole out in front of you, don’t think of debt as a bridge across. It’s not a bridge, it’s an anchor. And you’ll have to carry that anchor with you for some time after you’ve gotten past the present ditch in the road. It’s going to be hard enough to navigate the coming months, and probably years—being weighed down by the extra weight of that anchor could make the difference between scraping by, and going under.

There are various ways you might be inclined to use debt. You might have a personal line of credit available, or special offers for credit card lines at 0% for 18 months. You might have a business line of credit with your bank. Or you might be getting in line for the CARES options currently being made available.

Be Careful with CARES

Now, I’m not an accountant, and I have not looked in detail at the CARES options, but from what I’ve gleaned so far, these loans only turn into grants if you retain all your employees at their regular salaries. These loans will cover up to two and a half months of salary. There are other stipulations as well.

There are two big dangers in this deal. First is that if you do end up having to let people go, this grant will become a 4% interest loan, and so I think that most people will end up carrying it as normal debt in the end.

But the bigger danger is that this very stipulation may cause you to keep employees that you can’t afford, well beyond the two and a half months, because you don’t want to lose the grant provision. And in the end, after you’ve burned through this loan, you’ll still carry costs you can’t afford. That will reduce your operating revenue even more, and then add the debt for having kept those resources for the whole time. The incentives built into this program are the exact opposite of the real disincentives you need to be responding to, namely your loss of revenue and opportunity.

Are Your Debt Options Personally Guaranteed?

Even if you pass on the CARES Act loans, you may be inclined to use your existing credit lines. I’m not going to say that you should never do this, but I would strongly recommend that you think VERY soberly about this. Especially if your business line of credit has been personally guaranteed by you the owner.

Downturns stink. Laying people off, or cutting expenses is a painful and awful experience. But you have to play the hand you’re dealt. Playing up this gambling metaphor, it’s not the people who take money into a casino and lose it that suffer the most. It’s the ones who go borrow money hoping that the next bet will be the one that gets them back above water. They’re the ones who end up wearing cement galoshes. Don’t bet on your business using debt.

Do what you have to keep your business alive, cut your own compensation, make some deals with your clients, get scrappy. But don’t load down your backpack with heavy boulders of debt. We’re probably in for a long slow recovery, and you can’t afford any extra weight.

Using debt is something to avoid, but for more positive things you can do, check out that webinar. I focus more on making the most of the downturn, and the most of the extra time you’ll have on your hands as a result.

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