Everything You Need To Know About Debt Financing: Advantages and Disadvantages

Whether you need to start planning for a new property or you want to make sure that you have enough inventory, every business has certain needs where extra capital could be beneficial. However, it is also a known fact that securing money for business is not always easy and picking between the different financing options that you have can be overwhelming.

Out of the different options that people have, Debt financing is also a very common method used by business owners when they wish to secure funds for the business. Debt Financing is a preferred method because the method allows them to secure funds without giving up the ownership of their businesses. It provides people with the financial flexibility that assists them in the growth of their business; however, the method also comes with certain obligations that can affect different operations.

Just like any financial decision, it is very important for business owners to understand the benefits and drawbacks of debt financing. This guide explores all the different aspects of debt financing, along with its advantages and disadvantages, to make sure that you can make the correct decision for your business.

Introduction to Debt Financing

In layman's terms, Debt Financing is a financing method in which a company ask for money from an external source, such as a bank or a lender, and promises to repay it at a certain time in future. Unlike equity financing, debt financing relies on interest, which means that creditors are owed interest on the money that the company has borrowed. Lenders generally ask for monthly payments, whether the amount is small or large.

Debt finance also relies on peer-to-peer lending, which means that business owners ask for money from friends and family members in exchange for interest. Additionally, they can also apply for government-subsidised loans; however, these options are typically picked by small-scale businesses when they wish to acquire capital.

Exploring the Advantages and Disadvantages of Debt Financing

Along with knowing the debt financing definition, it is also necessary to be familiar with the benefits and drawbacks that this method entails. Knowing the pros and cons will make it easier for you to decide whether Debt Financing is the correct option for you or not.

Advantages:

1. Not Giving up Business Ownership - One of the biggest advantages of this method is that you do not have to give up equity to the people lending money to you. This ensures that your business will always be yours.

2. Tax Deductions - Another attractive aspect of Debt Financing is that there will be tax deductions on the interest payments that you need to make. The interest paid on business loans falls under tax deductions, which means this will significantly reduce your taxable income.

3. Lower Interest Rates - There are different options where you will find low interest rates. You can choose to secure funds through a credit card or ask your friends and family for money, and in these situations, the interest rate will be significantly lower.

4. Establishing Business Credit - Even if it is not known to a lot of people, debt financing also allows people to create a stellar business credit, which will assist them in future. This credit will also establish a good rapport with suppliers and create a strong track record.

Disadvantages:

1. Obligatory Repayment - It is very clear when you work with a lender that even if your business does not turn out the way you want it to, you have to pay the money that you owe to the lender. It is also possible that the collateral that you have mentioned can be sold to satisfy the debt.

2. Difficult Qualification - It is not easy for everyone to qualify for loans. There are different types of eligibility requirements that you need to fulfil, and even after that, you have to display a strong credit history to secure a loan.

3. High Rates - While low interest rates can be an advantage, high interest rates can make things challenging for you. If not explored thoroughly, you can suffer at the hands of predatory leaders who rope in small and new business owners.

These are the main benefits and drawbacks of debt financing that you need to know about, along with learning what is Debt Financing.