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5 Reasons Paying Down Debt Is a Critical First Step for New Entrepreneurs

5 Reasons Paying Down Debt Is a Critical First Step for New Entrepreneurs
Image credit: Chris Potter | Flickr
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If you’re planning to start a new business, paying down debt can be a critical first step in securing the success of your venture. Debt represents lingering obligations from previous financial transactions. Since you are entering a new phase in your life, the last thing you need to do is to be carrying those obligations into your new future.

You should make paying down debt -- or better yet, paying it off -- a priority. I mentioned several weeks ago in my post, 5 Powerful Books That Changed the Direction of My Life, about Dave Ramsey's Total Money Makeover having such a huge impact on my life because of my debt problem. Luckily, I figured out I had this "debt disease" before it was too late, and I hope the same is true for you.

There are at least five ways in which this will improve your chance of succeeding in business.

1. Minimize your cost of living.

Whenever you start a new business, cash flow is usually the biggest hurdle. You may even start the business with no cash flow at all. This situation can be at least partially offset by having a substantial amount of cash reserves that you can live off of for the first few months of operations. But those reserves will last a lot longer if your basic cost of living is minimized.

After being laid off from his corporate gig, Bob Lotich decided to attempt to turn his side business into a replacement for his day job.

“It could have never succeed if I hadn’t paid off my debt to minimize my cost of living.” Lotich says. “I was lucky to receive six months advance notice of the layoff, so for those six months I spent all my waking hours working to earn extra money to pay down our debt.”

Related: 4 Smart Money Habits to Help You Earn Your First Million Dollars

Any debt that you can pay off completely will be one less obligation you will need to cover out of a limited cash flow. That alone will improve your chances of succeeding in business. Cash flow is one of the biggest reasons for early business failures, and the better that you’re able to manage it, the less likely it will be to put an early end to your business.

2. Have a clean balance sheet at a time of transition.

Any time you start anything new, you should try to do it from a position of financial strength. A clean balance sheet is a sign of that kind of financial strength. Balance sheets are comprised of assets -- physical goods and financial instruments -- that represent the capital that you have available. On the other side of the balance sheet are liabilities. They represent liens against those assets, and a reduction of your net worth.

A balance sheet is never very important on a personal level. But once you start a business it suddenly becomes significant. Not only will future lenders be interested in the financial strength demonstrated by your balance sheet, but so will potential vendors, partners and even major customers. Each may want to know that you have the financial stability necessary to enter into long-term contracts.

The time to clean up your balance sheet is before you start your business. It will be much more difficult to do so after the fact, when your primary concern will be surviving the early months and years of building your business.

3. Clear your head.

Once you start your business, you will have concerns that you never had as a salaried employee. As I already stated, cash flow will be a constant concern. But you will also have to worry about marketing, supply chains, coordination with subcontractors and meeting customer/client obligations.

If you also have a bunch of debts that need to be paid each month, it will add a level of worry to an already crowded mind. Trust me, if you have a concern that’s even modest in scope before you start your business, it will only become more so later on.

You have a lot to juggle when you’re an entrepreneur, so you should do all you can to minimize the number of concerns that you have. Paying off debt is an excellent way to keep your head clear, and fully focused on your business.

Related: Don't Let Student Debt Hogtie Your Business

4. Remove risk to income-generating assets.

Most of us are more concerned with revolving debt, such as credit cards. But when you’re in business, the risk from secured loans can be even greater.

Should you fall behind in your credit card payments -- during a time of insufficient cash flow -- the credit card company will hound you mercilessly. Eventually they’ll place your account in collection, or obtain a court judgment against you. But none of these actions will affect your cash flow, and more important, none will subject important personal assets to seizure.

This is not true with secured loans. For example, if you have a car or business equipment that are necessary to the operation of your business, and each has a loan attached to it, you could lose either or both assets to seizure by a lender for nonpayment.

This will not only damage your credit, but it will remove those income producing assets from your possession. That could hurt your ability to earn income, and put you out of business.

For this reason, you may want to emphasize paying off secured loans ahead of revolving lines of credit. This will allow you to take income generating assets out of harm's way.

5. You may need to borrow later.

When starting a business, most people can easily envision the need to obtain credit to get the operation up and running. But an even greater need can arise a year or two later, when you need additional capital to expand the business.

Let’s say that your business is 2 years old, and you’re earning enough money to live. But if you could buy certain equipment, or move to a more strategic location, you could double or triple your cash flow. If your ability to borrow fresh capital is impaired by too many old debts, you may not be able to get the necessary cash for expansion.

Think of getting out of debt as a form of keeping your powder dry for a more important financing needs later.

The success of your business will rely on long-term thinking and planning. For that reason, you may be well advised to delay the opening of your business until you have a chance to pay down debt, and to pay off certain specific debts entirely.

The success of your business could hang in the balance.

Related: Mark Cuban on the Best Advice He Never Got