Debt financing, in plain language, means borrowing money to run or grow your business. With debt financing, you borrow money and promise to pay back the principle (the amount your borrowed) plus interest. The financing agreement specifies the amount of interest and a time schedule for repaying the debt. Once you pay back the principal and interest, you have no further obligation to the organization or individuals who loaned the money (the creditors).
Companies use debt funding for working capital (short-term expenses such as business operational costs and buying inventory) and for capital expenditures such as buying an expensive piece of machinery, buying a building, or acquiring other companies.
There are many types of debt financing available to small companies that qualify. Among them:
Depending on circumstances, the loans made to you will either be secured (require you to put up collateral), or unsecured (requiring no collateral.)
The differences between debt financing and equity financing involve the obligation to repay the money and ownership of the business.
Debt financing, no matter what form it takes, is basically a loan. The borrower is required to pay off the loan according to the terms of the loan agreement. The lender is entitled to nothing more than the return of their principle plus the agreed upon interest. The lender doesn’t own or control the business.
In contrast, equity financing is a way to raise money by selling ownership (shares) in a company. With equity financing, there’s no guarantee of repayment. Instead of getting a guaranteed payback of their investment, investors get a percentage of the business profits once it becomes profitable. Their percentage of profits will depend on numerous factors including the valuation of your company and percentage of the company’s shares they own. In addition, depending on the size of their investments, investors may become advisors to the company. They may also become involved with or even take over management decisions.
Here are the reasons debt financing can be beneficial:
Factors that will determine if debt financing is the right option for your business’s funding needs include:
Learn about the valuable resources ZenBusiness offers small businesses. We can help you with your business formation needs and provide you with needed services to start, run and grow your business.
As a small business owner, staying on top of your business’s finances is essential. Make the job easier by using ZenBusiness Money to invoice customers, keep an eye on receivables, and keep track of all your tax-deductible expenses.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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