The short answer. Safe debt clears three tests. Rate below the business's return on invested capital. Term matched to the useful life of the underlying asset. Post-financing Layer Cake that still clears MMP coverage. Below those tests, the safety hierarchy from safest to least safe: SBA real estate, SBA 7(a) equipment, SBA 7(a) working capital, commercial term loan, commercial LOC, invoice factoring, business credit cards, merchant cash advances. Each step down is roughly 2 to 4x the cost of the step above.
The Three Safety Tests
Rate below return on invested capital. If the business earns 15 percent on invested capital and the debt costs 9 percent, borrowing to invest produces a 6-point spread. If the rate is 22 percent, borrowing to invest costs more than it earns. Basic but often ignored.
Term matched to asset life. A 5-year term on a 10-year piece of equipment is fine. A 10-year term on a 5-year piece of equipment is borrowing against a promise that will not exist by year 6. The mismatch usually shows up in the second half of the term.
Layer Cake still clears. Post-financing MMP must be serviceable at current pricing with current volume. If it does not clear, the debt is speculative at best and a countdown at worst.
The Safety Hierarchy
SBA real estate loans. Longest terms (25 years), lowest rates (typically prime plus 1 to 2), backed by asset with long life. Safest form of small business debt if the property is a genuine operational fit.
SBA 7(a) for equipment. Terms match equipment life (typically 5 to 10 years). Rates prime plus 2 to 4. Second safest.
SBA 7(a) for working capital. Same rates as equipment but for a use with no matching asset. Third safest because working capital gets consumed and cannot be recovered on default.
Commercial term loan. Non-SBA, typically prime plus 3 to 6, 5-year terms. Fourth. Faster to close than SBA but more expensive.
Commercial line of credit. Variable rate at prime plus 2 to 5. Meant for working capital cycles, not permanent capital. Fifth.
Invoice factoring. 2 to 5 percent per 30 days on factored invoices. Effective annual rates 25 to 60 percent. Sixth.
Business credit cards. 18 to 28 percent APR. Seventh.
Merchant cash advances. 40 to 100 percent effective APR. Eighth and least safe. See the MCA explainer.
Why The Hierarchy Matters
Each step down the ladder is 2 to 4 times the cost of the step above it. Moving from SBA 7(a) at 9 percent to a credit card at 24 percent is roughly 2.7x. Moving from a credit card to an MCA is roughly 2x on top of that.
The compounding matters because most businesses that end up on MCAs got there by skipping the higher steps. They did not try the SBA. They did not open a bank line. They did not factor receivables. They went from cash to MCA in one move.
The doctrine on this is simple: exhaust the cheaper steps first, even if they take longer. An SBA loan that funds 45 days later at 9 percent is dramatically better than an MCA that funds tomorrow at 60 percent effective APR.
Frequently Asked Questions
What if I need cash faster than SBA can close?
Line of credit is usually the answer. A pre-approved LOC funds same-day up to the approved limit. That is why establishing an LOC before you need it is worth the time investment. Once you need it, the fast options are all expensive.
Are personal credit cards ever a safer option than business ones?
Personal cards are sometimes cheaper (lower APR) but they mix personal and business credit. That is bad practice long-term. Use business cards for business expenses. Keep the credit lines separate.
Should I ever use retained earnings to pay off debt instead of reinvesting?
Depends on the debt cost and the reinvestment return. Paying off 25 percent APR credit card debt is a guaranteed 25 percent return. Paying off 4 percent SBA debt when the business can earn 15 percent on reinvestment is a bad trade.
What about SBA disaster loans?
Very safe, very cheap, very limited. Only available during declared disasters. Take them when eligible. Do not build a plan around their availability.