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Preventing Startups from Falling Into Debt Trap
Preventing Startups from Falling Into Debt Trap

August 22, 2023

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"What is a debt trap?" You might wonder. For startups, it's a situation where they end up owing too much money. This can happen quickly, so startups need to be careful and take steps to avoid it. Startups work hard to succeed, but the pressure can sometimes lead them to borrow money. To stay safe, startups should make intelligent choices and avoid spending money on things that don't make sense. In this guide, we will learn about debt trap meaning and how to avoid falling into debt problems.

"A Debt Trap occurs when borrowing is used to meet the existing debt, leading to a cycle of unsustainable debt accumulation, causing financial instability and hampering growth."

1. Make a budget and stick to it.

Formulating a sound loan repayment strategy is crucial, just as understanding your monthly spending limits is vital. This is precisely where a budget plays an important role. While seeking professional advice is viable, you can also choose to adhere to the 5-step plan proposed by FreshBooks to establish a well-proportioned budget.

  • Calculate monthly income.
  • List recurring bills.
  • Include variable expenses.
  • Allocate for occasional costs.
  • Create your budget by combining everything.

2. Do the Math/Homework

Careful financial planning is crucial when considering a machinery or working capital loan. Calculate EMIs and assess upcoming financial commitments affecting your loan repayment capacity. Also, analyze impacts on other expenses like rent, utilities, and employee wages.

Taking a loan is also a good option.

But before applying for loan, you need to ask few questions to yourself, such as:

  • Does the loan provided by the bank align with your intended purpose?
  • How will securing this loan affect your cash flow and budgetary plans?
  • Is substantial collateral a requirement for this loan?

Once you've researched extensively and pinpointed a loan solution you believe you can comfortably repay, the subsequent task involves crafting your budget.

3. Avoid credit cards and other additional debt.

The debt trap is a severe pitfall for startups. A major mistake is assuming too much debt, increasing the risk of defaults and harming your business. Only take on a manageable debt load. Also, create a solid plan for using borrowed funds effectively.

Plan a budget-friendly weekend trip with friends, covering lodging, transport, and meals. Avoid overspending on spontaneous activities like spa treatments or extravagant dinners, which can strain your budget and lead to tapping into unplanned funds. Stick to your initial expenses for a stress-free trip.

4. Make some money on the side.

While waiting for your startup to achieve profitability that supports its expenses, exploring the fastest way to get out of debt through earning a supplementary income might be wise. With a reliable income stream, managing your financial responsibilities becomes easier.

Boost your earnings via eBay sales, affiliate sites, or even a second gig as a consultant or convenience store worker. These swift strategies can aid debt relief and showcase the resilience of determined entrepreneurs.

5. Live within the Means

Often, startups get caught up in the excitement and spend or invest more than they can realistically afford. Taking an extravagant approach to expenditures and investments is not a sound decision.

Suppose you're in the process of securing a business loan. In that case, it's vital to thoroughly assess your actual requirements and refrain from taking out a loan that exceeds those needs, always considering the additional burden of interest payments.

Financial prudence is vital for startups to avoid detrimental overspending.

6. Consolidate and prioritize your bills.

If you've just graduated, you're likely aware of the option to consolidate your loans. This involves pooling together multiple loans that usually involve dealing with different companies or debt collectors. The result is a single monthly payment, often at a lower interest rate.

Explore the "debt snowball method" by Dave Ramsey. Start by paying off your smallest debt, using the saved money to address the next one, creating a repayment cycle. With discipline and smart financial choices, you can swiftly eliminate debts. When funds are limited, prioritize essential payments like taxes and payroll over less urgent ones like credit card bills.

Conclusion

In the world of startups, avoiding too much debt is essential. This can help the business succeed in the long term. Being stuck in debt can prevent a startup from growing, being creative, and might even make it go out of business. But if startups are careful with their money and make wise decisions, they can manage their money well and avoid this issue.

 


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Tanvi Kaushik
Content Marketor

Tanvi Kaushik specializes in Content Marketing and works with the Digital Team at KreditBee.

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