With debt financing, you are borrowing money from a lender. The debt can be repaid in installments or all at once. Debt financing is often used by small businesses to purchase equipment and other assets that they need for the business to grow. It’s also common for debt financing to be used as working capital when cash flow is tight, or if there isn’t enough time allowed on credit lines before funds are needed again.
This post will discuss debt financing so your business can decide whether this type of funding is right for you!
What is debt financing
Debt financing is a finance mechanism in which a borrower obtains capital by issuing securities. The lender does not have an equity stake in the company, and the debt’s interest doesn’t create any shareholder privileges or obligations for repayment. In other words, it’s borrowing money from someone that has no legal claim on your company. Debt finance can be used to encourage investment by providing investors with downside protection, but only if the expected return exceeds the cost of carrying debt over time. However, there are still pitfalls – companies whose anticipated wealth generation is uncertain may suffer from high levels of uncertainty risk right out of the gate unless they can make a contractual commitment for renewing borrowings to repay them at a later date.
Why do small businesses need debt financing
Small businesses need debt financing to fund growth, invest in equipment and inventory, improve cash flow, and pay off existing debts. It’s a way for business owners to work on the parts of their company that they can’t or don’t want to handle themselves without an added time commitment. For example, a small business owner may need a new warehouse but prefers not to manage operations at this location during the day. They can leverage debt financing to acquire the necessary equipment and hold onto the profits from operations instead of employing management staff during those hours. By freeing up their time so they can focus on other aspects of managing their company – such as marketing or strategic planning.
The types of debt financing available to small businesses
Debt financing can come in a variety of forms, but they all have one thing in common – they’re secured by the value of the business. The vast majority of debt financing for small businesses is what’s called “straight debt.” Straight debt is a form of revolving working capital that comes with an interest rate and is often tied to a specific project or investment. It may be essential for ensuring adequate credit levels, whereas some lenders may require it as part-payment from the borrower if more money becomes needed. In certain cases, straight debt repayments are even timed to coincide with project expenses.
How much does it cost for a business to borrow money from the bank or another lender
The likely answer to this question will depend on the type of credit facility being considered. Commercial term loans are typically priced as LIBOR plus a specified spread because these are short-term loans with relatively low risk profiles for banks. Conversely, projects requiring longer-term leverage may entail more complicated pricing structures that take into account other factors such as perceived risks, benchmark rates for different types of loans, target market segmentation, and other values influenced by the values in the marketplace at any given time. The bottom line is that there isn’t one single answer to the question – it all depends on what type of financing is being negotiated!
When should I use debt financing instead of equity funding, and vice versa
It’s best to use debt financing during the early stages of the company when backup funds are not readily available. Equity funding should be used later on in the life cycle of the company for expansion funding. Debt financing is often preferable to equity funding because it doesn’t require giving away ownership (and thus potentially, control) to another person or partnership, so there’s no risk involved with losing control over your business. Debt financing also usually has a lower cost than equity financing but does come with other financial risks, so you should take this into consideration as well before committing to either option.