Debt financing is a method of raising capital for businesses by borrowing money from financial institutions, investors, or private individuals. Generally, merchants borrow these funds for operational or capital expenditures and repay them fully with interest.
Debt financing can be secured, which means that the borrower pledges some asset as collateral, or unsecured.
Secured debt financing is generally available only to larger companies with substantial assets that the lender can seize if the borrower defaults. Unsecured debt financing requires no collateral and is often available for smaller companies without large assets.
How Does it Differ from Equity Financing?
Unlike debt financing where a business borrows from a lender, equity financing occurs when a business sells some portion of its ownership in order to raise money.
A typical example is when an investor buys shares in a company in exchange for an investment in the firm. Equity financing can be used by startups and also by established companies looking to raise capital without incurring any additional debt.
How Debt Financing Works
This type of funding works in three different ways:
1. Installment loans
This type of loan requires a fixed amount every month with a specific time frame. The repayment period may be short-term or long-term, depending on your choice and finances.
2. Cash flow loans
These are cashflow-management loan products like merchant cash advances. They usually have a flexible payment schedule. The benefits include no interest charges and lower interest rates.
3. Revolving loans
They work like credit cards in that they have a limit on how much you can borrow, but they don’t come due at any specific time. You can take out a revolving loan, make payments on it for several months and then use it again when needed.
Types of Debt Financing
There are many ways to finance business operations.
- A traditional loan from a bank offers a long-term payback period with interest charged on the principal.
- Merchant cash advances offer short-term funds with no collateral necessary and no agreement for future repayment.
- SBA loans allow borrowers to borrow from the government at low rates with relatively easy terms.
- Equipment loans offer businesses a way to acquire or upgrade equipment and pay for related costs such as installation or training.
- Venture debt financing enables smaller companies to access large amounts of capital by tapping venture capital firms and private equity investors who usually invest in later stages of development.
Lastly, business credit cards also provide companies with short-term revolving lines of credit, often at low-interest rates.
Debt financing has its pros and cons. Before taking any loan type, do plenty of research to determine its possible impact(s) on your bottom line.
Author Bio:- Payment industry guru Taylor Cole is a passionate payments expert who understands the complex world of best payment providers. He also writes non-fiction on subjects ranging from personal finance to stocks to cryptopay. He enjoys eating pie with ice cream on his backyard porch, as should all right-thinking people.