Debt Financing For Small Businesses
While traditional bank loans are a good option for large businesses, many small businesses must turn to alternative sources of debt financing. Since the 2008-09 financial crisis, traditional lending sources, such as investment banks, have become less willing to lend to small businesses. These traditional lenders often favor well-established businesses that have a predictable cash flow, sufficient collateral, and a favorable debt-to-income ratio. A new small business might be better off seeking debt financing from a business development company.
According to Joseph Stone Capital Debt financing comes in several forms. Some investors are looking for protection of their principal, while others want to earn a return in the form of interest. Interest rates vary, but they generally correlate with market rates and the borrower’s creditworthiness. Higher rates imply higher risk, but they compensate for the risk. Debt financing often imposes covenants, or rules of financial performance that the borrower must follow. These rules are often referred to as “guaranteed repayment.”
Besides being tax deductible, debt financing offers several other benefits. Because the lender does not control your business, it is much easier to budget and forecast your expenses. Because interest is tax-deductible, debt payments are easy to predict. And because the debt is a legitimate expense, it is easy to budget accordingly. However, remember that you must still pay your debt regularly. Whether you are looking for debt financing or another option, be sure you are confident in your ability to repay the debt.
Joseph Stone Capitalsays As with any financial tool, debt financing is an excellent way for companies to invest in resources and services. Most companies will need some form of debt financing at some point, whether they are new or old. Most companies need access to capital to invest in equipment, supplies, inventory, real estate, and other resources. Debt financing is a valuable option for small and mid-size businesses. And it can make the difference between success and failure.
While equity financing requires that you sell a stake in your business, debt financing gives you the flexibility to retain control of the company. In contrast, equity financing requires that you sell a portion of your business to investors. With debt financing, you have no equity stake in the company and the relationship ends as soon as you repay the loan. While interest rates vary, they are generally low, making debt financing a valuable option for small businesses.
Debt financing is a time-bound activity, requiring the borrower to repay the loan, along with interest. These payments can be made on a monthly, half-yearly, or toward the end of the loan’s duration. A secured loan involves the attaching of assets, such as real estate, to secure the money for a business. This type of financing is usually more beneficial than equity financing, since the lender holds the right to demand repayment in full.
The total cost of capital is the sum of the interest paid by a business on its debt and equity. A high D/E ratio means that a company borrowed heavily on a small base of investment and aggressively financed its growth with debt. If the ratio is high, a company may be considered highly leveraged, which means it’s taking more risks on debt than it has in equity. In addition to the cost of debt, a company’s D/E ratio indicates the amount of equity it has compared to its debt.