Debt financing for your business is something you likely understand better than you think. Do you have a mortgage or an automobile loan? Both are forms of debt financing. It works the same way for your business. Debt financing comes from a bank or some other lending institution. Although it is possible for private investors to offer it to you, this is not the norm.
Here is how it works. When you decide you need a loan, you head to the bank and complete an application. If your business is in the earliest stages of development, the bank will check your personal credit.
For businesses that have a more complicated corporate structure or have been in existence for an extended period time, banks will check other sources.
Before applying, make sure all business records are complete and organized. If the bank approves your loan request, it will set up payment terms, including interest. If the process sounds a lot like the process you have gone through numerous times to receive a bank loan, you are right.
Advantages of Debt Financing
There are several advantages to financing your business through debt:
The lending institution has no control over how you run your company, and it has no ownership.
Once you pay back the loan, your relationship with the lender ends. That is especially important as your business becomes more valuable.
The interest you pay on debt financing is tax deductible as a business expense.
The monthly payment, as well as the breakdown of the payments, is a known expense that can be accurately included in your forecasting models.
Disadvantages of Debt Financing
However, debt financing for your business does come with some downsides:
Adding a debt payment to your monthly expenses assumes that you will always have the capital inflow to meet all business expenses, including the debt payment. For small or early-stage companies that is often far from certain.
Small business lending can be slowed substantially during recessions. In tougher times for the economy, it can be difficult to receive debt financing unless you are overwhelmingly qualified.