The pros and cons of debt financing
One of the most common kinds of financing that most business owners try to obtain is debt financing. However, it is important to understand that there are different types of financing and one may work better for your business then another. You should make sure that you become fully educated on each type of financing in order to make the right decision for your business. It is important to keep in mind that each type of financing comes with its own pros and cons. When you fully understand this you can choose the type of financing that works best to meet your business' needs. Here is what you need to know about the pros and cons of debt financing-
The most basic definition of debt financing is that you borrow money to start your business or to provide it with more working capital. Most business owners will start by looking at their own finances and then they may approach family and friends with the opportunity to invest in their business. Finally, they will approach lenders (banks, credit unions, SBA etc.), about obtaining a business loan. There are several pros to this type of financing that include:
- You keep control of your business-Unlike equity financing where you are actually selling pieces of your business with debt financing you keep total control of your company.
- You can do what you want with the money-Because there are no shareholders who have a say in what you do you can use the money for whatever you want to.
- You may save on taxes-In certain circumstances the interest on your loan can be tax deductible. This means that you can lower the tax liability for your business.
- You may receive an incentive-There are certain programs that offer incentives for small business owners to take out debt financing. This is done in an effort to stimulate business development.
- You only owe the lender timely payments-All that will be required of you is to make your loan payment on time and in full.
Now that you know the pros of debt financing it is equally important to understand that there are cons, as well. Knowing both sides of using debt financing will help you to make the right decision for your business.These cons include:
- You can burden your business-Depending on the age of your business taking on debt financing can be a serious burden that can slow growth and development.
- You risk your credit-The bottom line is that if you cannot make your payments on time then you are risking your business credit. If your credit rating is severely damaged you should realize that it will make future borrowing almost impossible.
- You put your personal relationships at risk-If you have borrowed from family and friends and then have difficult paying them back you can risk personal relationships.
- You may have to come up with collateral-If you are taking out a business loan you may need collateral to secure it. This puts whatever you offer for collateral at risk. For this reason you should never pledge something that you cannot afford to lose such as: your home, car, or other expensive item. Keep in mind that if you cannot make the payments you will lose the collateral.
- You are risking bankruptcy-Studies show that the higher the amount of debt financing that a business has the higher the risk of bankruptcy.
Once you have studied the issue of debt financing carefully then you can decide if it right for you and your business. Should you decide that debt financing is not right for you keep in mind that there are other ways to get needed funds for your business.