How Can Debt Financing Help You Start Your Own Business
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So, you already have this revolutionary business idea in your head, and you’re about to tackle the daunting task of lifting it off the ground.
Starting a business is a journey worth taking. But, as with all journeys, there will be many ups and downs. One sobering thought you might come across as early as now is that the financial side of running a business is one of the most challenging aspects you’ll have to face sooner rather than later.
Paying taxes, getting investors, and knowing how cash flow works—are just some of the things you’ll have to learn along the way. Money talks, and it’s what will keep your business going.
However, when starting up your business, you pretty much have limited sources of internal financing. Eventually, you’ll have to rely on external sources. Using debt to build wealth is one of the most common external financing sources for business operations. Of course, before you weigh in on how debt financing can help you, it’s important to understand what it is first.
What Is Debt Financing?
Debt financing is when you borrow funds from creditors with the promise to pay back the borrowed funds plus interest at a specified later date. The interest on the amount provided to the borrower serves as compensation for the creditors for providing debt financing.
It’s basically the same concept as when you take out an automobile loan or a mortgage. Typically, the source of debt financing is a bank or other lending institution. You might also be able to acquire debt financing from private investors. However, this is uncommon.
Debt financing can be secured or unsecured. Secured debt has collateral or a valuable asset that the lender can attach to satisfy the loan in case of default by the borrower. Unsecured debt, on the other hand, lacks collateral and puts the lender in a less safe position with regard to repayment in the event of default.
The repayment schedules for debt finance can be either short-term or long-term. Long-term debt is typically used to fund assets like buildings and equipment, whereas short-term debt is used to finance ongoing operations.
How Does Debt Financing Work?
Here’s how debt financing typically works:
- Once you’ve decided that you need a loan, you go to the bank and fill out an application.
- If your business is still in its infancy, the bank will review your personal credit.
- Banks will check other sources if your business has a more complicated corporate structure or has been around for a while.
- Along with looking at your business’s credit history, the bank will examine your books and perform additional due diligence.
With all of these in mind, you must ensure your business’s records are complete and organized. If the bank grants your request for a loan, it will establish the payment terms, including interest.
How Can Debt Financing Help My Business?
Debt financing has multiple benefits for businesses. Let’s dive into each below:
Have Management Control
When you accept debt financing from a lender, the lender does not influence how you run your business. The power to make decisions is still yours! Your business relationship with the lender ends when you’ve fully repaid the loan.
Enjoy Tax Deductions
The interest payments on debt financing are considered an expense and are, therefore, tax deductible. This one feature of debt financing contributes to the fact that it is a more attractive method of financing than the use of equity.
With debt financing, you are completely aware of the exact principal and interest payments you will need to pay back each month. Therefore, it will become a fixed expense, making the creation of your budget and financial plans easier.
Build Business Credit Score
It’s easy to think that debt financing harms businesses because no one likes debt. But, in reality, the opposite is true! Businesses can actually raise their business credit score by demonstrating their ability to manage debt, such as by consistently making payments on time.
How Do I Know If Debt Financing Is Right For Me?
Debt financing is not for every business owner, as it can quite literally make or break your business. That’s why you need to know if it’s the right business move at the moment.
- What stage is my business currently in?
- Is my business able to qualify for debt financing? How is my credit history? Do I have a good credit rating?
- How vital is it for me to retain complete control of the business?
- How important is it to know exactly how much my business has to spend each month?
- Am I organized enough to make consistent monthly payments?
- Do I have any collateral I can use? Am I comfortable with using it?
Fund Your Business Growth
Raising money and finding the right kind of funding for your small business will take a lot out of you. But all the time and effort you put into it will be worth it, especially when you finally see the fruits of your labor! For now, however, it’s crucial to weigh your options and choose the funding option that best fits your present financial circumstances and business objectives.
For more insightful articles and actionable tips about finance and business, check out Capital for Business’ The Working Capital and Financing Blog.
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