You’re an entrepreneur. You’ve climbed your way up on your own hard work and dedication and you are tireless at keeping your company in the best standing you possibly can. But lately, you’ve noticed a drop in capital. Your margin of gains is getting smaller and smaller. Sound familiar? Don’t fret. There are options available to you so that your hard work doesn’t go in vain. If you need to create some extra capital, you might want to consider debt financing for your business.
What is debt financing?
What is debt financing, you ask? And why does it sound like an oxymoron? It’s not an oxymoron and it’s actually a great resource available to you. Debt financing is a method of borrowing money from a third party source to pay back at a mutually agreed upon level of interest. Debt financing is also an opportunity for growth, for gain, and for more business.
If you decide that debt financing is for you, all kinds of opportunities become open to you. With the extra capital, you can fund new buildings or extra office space, equipment, expansion of your company so that you have an online presence, or other assets you will use to grow and expand your business. Having all these options available to you is a great way for your company to grow aggressively with a new business strategy, to make new hires, or make changes you’ve been meaning to make within the company.
One of the biggest advantages to debt financing is that you can negotiate a relatively low interest rate which allows you to pay back the borrowed capital in installments over a long period of time. This means you have the money in your possession longer, which means you’re able to do more with it. This is similar to the practice of equity financing in as much as you have the benefit of not relinquishing any ownership or control over your business, because the last thing you want to do is give up control of your venture just to have a few extra dollars on hand.
Another advantage is the tax deductions. This is probably the most attractive feature of debt financing. Commonly, the principal and any interest payments made on a business loan are classified as business expenses, which means they can be deducted from the income taxes for your business. This relationship can be most easily illustrated if you imagine the government as a partner in your business with relation to your loan and whatever your business tax rate is.
With advantages naturally come detriments, one of the bigger ones being repayment. Regardless of whether or not your company grows and succeeds because of the debt financing, you are absolutely required to keep up with your payments. You are obliged to your lender. In the undesirable circumstance that you need to claim bankruptcy, your lenders can claim repayment before any other equity investors.
Another disadvantage to debt financing is the high rates of interest which are influenced by macroeconomic conditions, your personal credit score and history, your business’s credit score and history, and your unique relationship with your bank. As such, your interest rates do not necessarily have to be high. If you have an exceptional score and your business is in good standing, you could probably get away with a lower rate than the average.
Another feature of debt financing can either act as an advantage or a disadvantage as it has to do with the financing influencing your credit score. You can either affect it positively and stand to gain a better standing than you already do or it can suffer if your investments go sour and become strapped for cash. A poor credit score can affect the future of your business and influence whether or not you are able to secure other loans, finance other debts, or attract new investors. Alternatively, a good credit score opens up endless opportunities for you and your company. You’ll be able to get new financing as you need it, investors will have confidence in making contributions, and your interest rates will more often than not be at a rate favourable to you.
If you decide debt financing is for you, you have two options to go with: secured debt or unsecured debt. Secured debt is a debt that is considered secure because creditors will have recourse to the assets of the company. A secured debt loan is usually divided into long term and short term debt.
Unsecured vs. Secured Debt
Unsecured debt is considered insecure because creditors do not have recourse to the assets of the company. The risk with unsecured debt is solely to the creditor because they cannot go after any of the company’s assets in the instance of their investment going belly-up. As a result of this risk, unsecured debts usually come at a gargantuanly high interest rate.
After deciding whether you want to go with secured or unsecured, you can finance your debt through several different sources. Most commonly, businesses seek loans through private sources ranging from friends to relatives to rich acquaintances. The biggest advantage to this type of arrangement, especially if your private source is a friend or a family member, is that the terms of the loan are bound to be favorable and flexible. You also have the added benefit of a friend loaning you money without much convincing. On the downside, your friends might over involve themselves in your affairs and want to try and contribute to your business.
If private sources aren’t for you, the banks are tried and true sources of capital. Banks have a tendency of being risk averse and are cautious when making loan deals with those seeking. As a result of this conservative practice, it could prove difficult to secure a loan if you’re just a small business with little to show. But, different types of banks mean different kinds of dealings with it comes to debt financing. Your best bet is to seek out a commercial bank that is sure to have a substantial amount of experience making business loans. But, regardless of the bank you opt to approach, do your research about their terms and their interest rates and choose wisely according to what will benefit you.
Alternative to private sources are public sources. The federal government sponsors a vast number of programs that provide funding specifically to foster and bolster the formation of businesses and to help strengthen small businesses. These programs are handed by The US Small Business Administration (SBA) and are built off debt financing. They help businesses acquire funding through banks or other lenders and can guarantee loans as substantial as half a million dollars for an average of 2.75 percentage points above prime lending rate. The one thing to keep in mind when applying for public loans is that in order to qualify, you must first be turned down for loan applications through conventional channels. Public sourcing a loan is meant as a leg up for businesses.
Another way to secure debt financing is through specialized finance companies. If you choose to go this route, it’s important to keep in mind that these companies have a tendency of charging higher interest rates than banks or credit unions. They’re also more likely to approve a loan, especially from a start-up company or a smaller company that isn’t as established as its competition. If you’re approved for a loan, it will more often than not be through a secured loan where assets are surrendered as collateral that can be seized if the entrepreneur defaults on the loan. Their interest rates are often comparable to those of commercial banks, but finance companies will expect more assets to be made available as collateral for a good rate.
While there are quite a few substantial drawbacks to keep in mind when considering debt financing, the advantages far outweigh them. Think of all the good you can do with supplementary funds. You could expand the way you’ve needed to for the past couple months. You can pay for the changes in your business plan that you’ve been meaning to make.
You can hire a few extra employees to ensure long term financial gain. With capital comes freedom and with freedom comes changes that could strengthen your company in invaluable ways. Take control of your business and show what kind of leader you are by capitalizing on the funds that are available to you through debt financing. It may seem like you don’t need the extra capital, but really look at your business. Are you doing all that you could be doing for yourself? Your employees?
There’s always more to be done, and more can be done with the help of a loan. Money may not be the answer to all your business’s issues or problems, but it certainly can help with a few and soften the blow where necessary. Consider it as the extra boost of energy to push you the extra mile to set yourself apart from your peers and your competition. Do what they won’t or don’t do. Be a leader.