Borrowing is one of the most consequential decisions a business owner can make. It can fuel growth or quietly erode profitability through interest drag, overextension, or mismatched timing.
When interest rates skew higher, these decisions become even more critical. Loan structures that worked at 6% can strain cash flow at 15%. Add to that the risks of unpredictable revenue, supply chain disruptions, and project overruns, and it becomes clear that borrowing wisely requires precision, not guesswork. The challenge is to secure enough capital without straining your resources or exposing your business to unnecessary risks.
Borrowing More Than You Need or Just Enough?
Conventional wisdom says to borrow more than you think you’ll need. But when borrowing costs climb into double digits, that “buffer” can become an expensive liability.
Consider a $100,000 SBA 7(a) loan at 15.5%, amortized over five years. Total interest payments would exceed $40,000. Now, imagine you revisit your capital plan and determine that $90,000 is sufficient. Under the same terms, that modest adjustment could potentially save more than $4,000 in interest payments. While that difference may not look like much on paper, it’s money that could go to work inside your business instead of flowing out as interest. It might provide a modest cushion during a slow month or cover an unexpected expense. Small optimizations in loan sizing compound into meaningful flexibility over time.
And it’s not just about the interest. Over-borrowing doesn’t just cost more – it reduces operational flexibility, increases fixed costs, and compresses margins, especially during periods of volatility. Many business owners think of debt as protection, but unless it’s being put to productive use, it’s more accurately described as a penalty on your future options.
What’s the Real Cost of Borrowing?
Understanding the true cost of debt requires more than glancing at the nominal interest rate. If your business qualifies to deduct interest expense, and many do, your after-tax borrowing cost could be lower than it appears.
Generally speaking, Section 163(j) limits the deductibility of business interest to 30% of adjusted taxable income for businesses with more than $25 million in average gross receipts. It’s a bit more nuanced than that, but for many small and mid-sized businesses, the 163(j) limitation isn’t a concern.
Consider a loan at 15.5% interest over five years. While the nominal rate is 15.5%, the ability to deduct interest payments can push the real after-tax cost closer to 11%, depending on your effective marginal tax rate. Even though this difference might not appear dramatic at first, it represents real money that can be reinvested into your operations or used to protect your cash flow.
Planning for Contingencies Without Overpaying for Them
One of the most common borrowing missteps is using long-term debt to cover unknowns. It makes sense in theory: build in a cushion for the unexpected. But with many loans, where proceeds are disbursed in full shortly after closing, you’ll start paying interest on every dollar, even if it sits untouched in your account for months.
The better approach is to segment your financing. If you’re considering an SBA loan at double-digit interest rates, use it for essential, known expenditures and core costs. But consider a separate, more flexible tool for contingencies. A business line of credit is particularly well-suited here. It gives you access to funds without interest unless you draw, and can be activated quickly if cash flow falls short or expenses rise unexpectedly.
Lines of credit may be secured by receivables, inventory, or general business assets. If your business has strong financials, some lenders will offer unsecured lines with streamlined approvals, though limits may be modest. The key is timing: secure the line when cash is strong, not when you’re in crisis.
Timing and Structure Matter
How and when you borrow can be just as important as how much. Borrowing immediately after a fiscal year-end may provide the clearest financial picture and allows your CPA to model future cash flows with greater accuracy. It’s also a natural inflection point to reassess whether current-year needs justify debt or can be met through retained earnings. Some options include:
- Interest-only period SBA loans: Lenders may offer a period of interest only repayments of 6-12 months during ramp-up or construction phases. These can smooth the transition into full repayment, especially if your business won’t generate immediate returns from the loan-funded investment. But this feature must be negotiated upfront and may be limited to specific use cases.
- Milestone-based drawdowns: These loans provide more control may be harder to secure. SBA 504 loans may permit these types of withdrawals for construction or phased expansion, but you may need to find private or alternative lenders to secure this type of loan.
- Asset-backed loans: These often carry lower rates and longer terms. If you’re financing equipment or property, collateralizing the loan can significantly improve your repayment timeline and your cash position, even if it introduces some personal or business risk in the event of default.
Entity Type and the Hidden Tax Dynamics of Debt
Debt also interacts with your legal structure and tax basis in important ways. In pass-through entities like S-Corps or LLCs, your ability to deduct losses or benefit from business deductions can hinge on how debt is incurred and by whom.
For example, if you personally lend money to your S-Corp, that increases your basis in the company. Basis is the measuring stick the IRS uses to determine how much loss you can deduct on your individual return. If the company takes on third-party debt, but you’re not personally liable, your basis may not increase, limiting the tax benefits of losses or deductions tied to that debt.
This becomes especially relevant in years of investment or early-stage growth, when losses may be large but deductible only if you have enough basis. It’s a subtle but critical detail that can alter both your tax position and how you structure your financing.
Aldrich Insights
- Your nominal rate isn’t the same as your real rate and understanding that gap is crucial for making informed borrowing decisions.
- Overextension can lead to business distress, especially when fixed obligations begin to crowd out operational flexibility.
- Working with a trusted advisor to model the year-by-year deductions based on the loan specifics and your projected taxable income can help you fully evaluate the cost. Advisors can help you better understand your effective interest rate and the true cost of the loan.
- The lender, loan type, and structure should all be influenced by your overall goals, company type, and financial focus.
- Run scenarios. What happens if revenue dips by 15% for two quarters? If a key contract doesn’t close? If rates climb another 100 basis points?
