Debt Financing for Businesses— Advantages and Disadvantages

There are times when businesses need more money than they currently have. When that happens, they have three ways to get financing—debt, equity, or a combination of the two. If you want to maintain full control of the firm you own, then you should choose debt financing.

Debt financing occurs when a company sells fixed income products, such as bills, notes, or bonds. This is one-way owners can get the funding they need to grow their operations. Investors who buy the bond are lenders who provide this financial solution to the company.

The owner must pay back the amount of the loan at the agreed date. If the company files for bankruptcy, lenders have first priority on liquidated assets, ahead of shareholders.

Advantages of Debt Financing


  1. Maintain Ownership of the Company


The owner needs to pay back the amount borrowed to the lender. After paying off the financial obligation, owner’s responsibility to the lender has ended. The owner maintains full control of the organization without any interference from the lenders.


  1. Acquisition Proceeds


Once an acquisition occurs, the proceeds will go to the company, instead of being divided among lenders, because most acquisition contracts have no specified plan to pay money to investors.


  1. No Surprises


The debt-financing agreement states the total amount of payments to be made each month. It is, therefore, easier to include the amounts within the company’s budget. Lenders agree on the terms and conditions of the loan before releasing the money.


  1. Tax Benefits


Financing business debt is considered as an expense, which makes it tax deductible. Owners can deduct the total amount from the income taxes of the organization. Owners should consult a Certified Public Accountant (CPA) about what effects of the financial solution might have on taxes.


  1. Lower Interest Rates


A Small Business Administration loan provides low rates and long terms. Even if the company doesn’t qualify for an SBA loan, you, as the owner, can apply for other loan options. Just make sure that the lender is transparent with all terms and fees.


Before signing for a loan, make sure that you understand the total payment. If there’s more than one installment a month or the calculations are complicated, it’s better to find another lender.


  1. Establish Business Credit


A good credit record is important to gaining access to long-term financing at low rates. Taking out a loan is a good way to establish the company’s credit. That way, the business doesn’t have to rely on expensive financial solutions for funding. Vendors also view good credit as an indicator of how the owner is running the firm. The better the record, the more favorable the terms will be.


  1. Foster Growth


Businesses use finance tools to purchase equipment, increase marketing effort, hire new employees, advertise, upgrade, etc. By taking out a long-term loan, the company gains access to the funds required to keep the operations running smoothly.


  1. Save Money


One advantage of getting a same day cash loan is that the company doesn’t need to rely on expensive financial options like cash advances and credit cards. This type of business financing allows you to pay off expensive financial burdens and will reduce the number of monthly installment payments. It will greatly improve the corporation’s cash flow.


Disadvantages of Debt Financing


  1. Strict Requirements   


The business venture and its owner must have an adequate credit score to qualify for financing. It is a price to pay in order to get better terms and cheaper rates, though.


  1. Must Repay the Lender


Even if the corporation doesn’t do well, the owner must pay the lender as stated in the terms of the contract. Most lenders require collateral, and the firm may be forced to sell assets in order to repay the loan if it runs out of money.


  1. Pay Interest


Probably the biggest disadvantage of financial tool is the interest. The company needs to pay the total amount as stated in the terms of the contract, including principal and interest. Owners should also be aware of predatory lenders who take advantage of the monetary needs of unsuspecting owners.  


  1. Impacts Credit Rating


The credit report shows every loan you have. Therefore, getting loans before paying off a current one can affect your rating. The company that borrows a great deal appears as a higher risk to lenders.  As a result, lenders offer higher rates on potential future loans.


  1. Cash Flow Problems


Most owners opt for this financial tool when their company experiences a cash flow problem. There are instances in which injecting more funding into the organization will not solve the problem. As a result, the company will find it hard to keep repayments current. If you are already late in paying the bills, getting additional loans might just add to the problem.


Alternatives to Debt Financing


Nevertheless, owners can choose other solutions to their financial problems aside from the mentioned tool previously. These include equity financing, mezzanine financing, and hybrid financing. The latter is a combination of both debt and equity financing.

When looking for more capital, owners must consider the pros and cons of all the options first. There is no perfect solution to the problem, and it is up to the owner to choose the best one for his or her operations.  

Owners should weight – all the factors involved so as to make smart decisions for the future of their company. Make sure that a business loan is a right choice or if you are better off with another financial solution for your funding problems.     


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