Running a small business can be a great pleasure. In fact, small business owners across America are some of the most satisfied people around. There really is nothing like being your own boss.
However, running a small business means huge challenges, and it can be hard to keep your enterprise afloat. You may need to consider options like debt financing to keep your company away from bankruptcy.
What are the advantages and disadvantages of bankruptcy? You’ll need to be familiar with both in order to determine if you’re making the right decision for your business. Read on and we’ll walk you through everything you need to know.
What is Debt Financing?
Maybe you’re not familiar with the concept of debt financing. What is it, and what does it mean for your business?
To put it simply, debt financing simply means selling bonds in order to quickly increase the cash flow coming into your business. Businesses sell bonds to investors and make interest payments on these bonds.
Eventually, when the company is back into a more stable financial state, they pay back the principal amount of the bond in full. In this way, a bond works much in the same way that a traditional bank loan might.
It’s a way for a business to weather a tough time by getting a quick cash flow going and paying it off later on. These bonds don’t impact shareholder equity, which means ownership in the company will not be diluted by accepting money from new investors.
Why might a business look at debt financing as a way to raise funds in an efficient manner? There are many reasons.
Advantages of Debt Financing
While debt financing works in much the same way as a traditional bank loan, there are some advantages that this method offers. For one, it’s generally easier to find interested investors than it is to find a bank willing to give you a loan.
As everyone knows, qualifying for a business loan from a bank in the modern era can be though business. Banks are notoriously risk-averse and turn down many more loan requests than they accept. Not only that, but the application process for a bank loan can be long and arduous.
If you need cash fast, you might not have time to wait through the entire bank loan procedure. Debt financing allows you to make direct contact with an investor who likely can get you the cash you need a lot faster.
The interest rate on bonds is also generally lower than it would be on a traditional bank loan. This is because a bond is generally seen by investors as a safer investment than putting money into stocks, for example.
As such, they’re willing to accept a lower interest rate. That means debt financing can actually save you money in the long run as opposed to going in for a bank loan.
In addition, the interest a business pays on bonds they issue is actually seen in the eyes of the government like a business expense. That means it can later be written off on your company’s taxes.
Last but not least, a bond helps business owners regain control over their company. Bringing on a true investor to take a stake in the company often means cutting this person into the business decisions.
A lender that purchases a bond has no say in business decisions and the relationship ends once the bond is paid in full.
Disadvantages of Debt Financing
Of course, nothing is perfect. There are some drawbacks and disadvantages to debt financing as a form of financing.
For one, it requires extreme discipline on the part of the business owner. Selling off bonds means you’ll need to stay up to date with a very rigid repayment structure. Interest will be due and you’ll need to pay up on time, every month.
Failure to do so could sink the financial stability of your business– the very thing you’re trying to bolster by debt financing to begin with!
You’ll also need to keep the future of your business in mind. A company that is too reliant on debt as a form of financing will be seen as ‘high risk’ by many investors. Too much debt could limit your ability to get investors to come on with equity financing at a later point in time.
The present is important, but you don’t want to prioritize it over your future either.
In some situations, you might need to offer collateral when you issue a bond to an investor. It depends on your credit background. If you do have to issue collateral, you’re putting one of your major business assets at an incredible risk.
If you fail to pay interest on time or pay the loan back in full, you could see an essential piece of equipment seized from your possession.
There’s a lot of considerations to balance when determining whether debt financing is right for your business. Only you know the particulars of your business, so only you can make the final decision at the end of the day.
Advantages and Disadvantages of Debt Financing
It’s a tough world out there for a business owner, and there’s a lot to think about when keeping your company above water. It’s important to understand both the advantages and disadvantages of debt financing before making any serious move.
The above information can help to ensure you’re informed before signing on any dotted line.
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