The Benefits of Debt Financing Loans for Small Businesses
Funding a business venture often rests on the ability to secure external financing. Though your businesses may be working well at the moment, purchasing new equipment, boosting your inventory supply, or hiring new talent may require an influx of cash. Debt financing is a common option for many small business owners, and here’s a quick breakdown of what it is.
Business owners who look to borrow money from somewhere outside the company, whether through traditional financial institutions or non-traditional lenders, are using debt financing. Much like any lending situation, the borrower agrees to a contract with an initial principal amount and interest rate that must be paid back over a specified time period. At times, assets of the company may be used as collateral to secure the loan.
In this financing process, the lender receives a payment each month according to the agreed-upon terms. This can create a hardship for businesses that don’t have a strong sales month. It can also require more paperwork and approval qualifications than other forms of financing, but the interest rates are generally much lower than other financing options. The interest paid on the loan can often be used as a tax deduction.
There are several benefits of pursuing this type of benefit, but there are also several disadvantages. Here is a general review of each.
- Advantages: Business owners are able to repay the loan in small monthly payments, and the lender has no say over how the funds are used. Business owners can also use the premiums and interest charges as a business expense, allowing them to be deducted from the income taxes. It is also easier to structure the monthly budget, as there is a fixed payment plan for the loan.
- Disadvantages: Cash flow challenges can make it hard for a company to meet the monthly responsibility of the loan, and the overall process will impact the company credit rating. This has the potential to be a benefit or a disadvantage. The need for collateral is also a disadvantage since it puts the business assets at risk. However, many business owners don’t have the funds or personal assets to secure the loan on their own, nor are they willing to put themselves at this risk.
Businesses of all sizes can take advantage of debt financing to grow the company or increase cash flow. Carefully weight the needs of your business against the benefits and disadvantages to be sure you are taking on a financial responsibility you can handle.