If you run a small business, it’s quite likely that you’ll need an external source of finance to meet your business needs, such as purchasing inventory, a piece of equipment, or hiring new employees.
In such cases, debt financing is one of the many solutions you can use to finance your business.
Often referred to as financial leverage, it provides extra working capital without giving up a portion of the ownership.
In this guide, we’ll be talking about everything you need to know about debt financing. Let’s begin!
The process of borrowing money from an external source with the promise to pay it back at the end of the loan tenure with the agreed-upon percentage of interest is known as Debt financing.
The loan could be in the form of a secured or unsecured loan, collateralized with the firm’s assets taking the loan, and the loans are given based on the valuation of those assets.
Types Of Debt Financing
Here are five main types of DF:
- Banks Loans
Bank loans are the most convenient type of DF. Banks offer a wide variety of loan options and interest rates based on the financial situation and needs of each company. Bank loans usually have a term between 3 to 7 years.
- Bond Issues
Bonds are loans taken out by individuals, companies, or organizations, and then they become creditors by loaning money to businesses in need of debt financing.
The bonds typically include a principal value, interest rate, and a repayment term of 10 to 30 years or more.
- Non-Bank Cash Flow Lending
Non-bank cash flow lending is an unsecured loan often used by businesses to finance the working capital of day-to-day operations such as payroll, rent, and inventory.
These loans are flexible and can be paid as a fixed amount over a specified period or as a percentage of sales you make until the principal amount is paid off.
- Credit Card Loans
Borrowing through a credit card is another type of debt financing in which you can get funds from a lender at a specified interest rate, monthly installments, and repayment based on your credit score.
- Family Loans
Another form of Debt Financing is borrowing money from family and friends through credit cards.
These are personal loans, where the borrower or the lender tracks the interest due and repayment schedules.
Pros & Cons Of Debt Financing
Here are some major pros and cons that you must consider before taking out any finances from an external source:
- Debt financing is an easy and accessible option for businesses of all sizes.
- It is the best way to retain the maximum ownership of the company.
- The payments are tax-deductible, which decreases the company’s tax obligations and interest rates.
- Regular monthly payments improve your credit scores enabling you to access more funds in the future.
- You must have a good credit rating to get qualified.
- Also, you have to put some of your business assets at potential risk.
- You must be financially disciplined to make all your repayments on time.
Amit Gupta is the founder of National Planning Cycles, a company that helps startups, individuals, and small businesses with their financial planning. He has a vast amount of experience in the finance sector, having managed Google Play accounts for some of the world’s most successful unicorns. Amit is an expert in his field, and he uses his knowledge to help others achieve their individual goals.