Everything You Need to Know About Debt Financing
There are many things you need to think about when you start a business venture. Whether it’s a full blown ecommerce business or a low capital reseller web hosting business you are starting, you will be busy.
Most likely you will be gathering the required resources, raising capital, setting up the initial framework and making major decisions about everything. Contrary to popular belief, equity funding (i.e., finding investors and business people to invest in your venture) are not the only ways to generate capital. Sometimes applying for a loan or credit line will make sense. Here, debt financing can be a smart way to generate instant cash reserves against company assets and accounts.
What is debt financing?
The proper definition of debt funding would be a method of financing where a company receives a loan and promises to repay the same with an agreed amount of interest. Debt financing solutions can include both secured and unsecured loans. However, most lenders today are conservative and will ask for some sort of collateral. In other words, your company will need to pledge some security against the loan amount taken. This is an assurance that the money will be repaid on time - or you can lose your collateral.
What are forms of debt financing?
Debt financing includes an array of robust, reliable funding options such as ABLs (asset-based loans), RBLs (revenue-based loans) and microloans that support small-scale industries. These loan programs allow quick money transfer and low-interest rates to help first-timers set up their business. Small companies can get both short-term and long-term loans depending on the nature and scale of their business.
Taking money from friends and family is also considered a debt financing solution. If you go this route, it is advisable you draw a legal contract so each party understands what is expected of them and that your contract is a legally binding document. This ensures better security and assurance that the money will be paid back.
Credit cards and venture debt are also a growing financing technique that allow faster, glitch-free transactions without the necessity of complicated paperwork.
Why is debt financing necessary?
Investments and personal assets may not fulfill the large capital requirement you need for your organization. When you need to make big purchases, grow your inventory, expand and so on, you may need to take on some debt. Credit funding and loans could be just the thing you need to support and grow your business.
Here are some advantages of debt financing:
- Greater Flexibility
Unlike investments, debt financing does not take away your control. You are free to use the loan amount any way you want. On the other hand, when you take on an investor, they will have equal say in the company and its direction. This can seriously hamper your control over your own venture. With debt financing, your only obligation is to repay the money back according to the terms you agreed to. What you do with the money is entirely your prerogative.
2. Tax Deduction Benefits
The principal amount and interest payable on a business loan is considered a business expenses and so are exempted from additional taxes. This can be a huge huge advantage for small-scale enterprises.
3. Lower Interest Rates
Most debt financing solutions, such as microloans and SBA-backed plans, are made for growing companies so interest rates are nominal.
So what are The Downsides?
Mainly, you have to pay it back. In the event you do not, you will lost whatever security you pledged against the loan. Also, many lenders will not trust a newbie with their money. In other words, if you do not already have a going concern, it may be more difficult to get a loan.
The Bottom Line
Any amount you borrow is considered a debt of the company and must be paid back. However, when your business is growing, there are times when you may need to take on debt. When these times arise, debt financing could be just the thing you need.