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Debt financing refers to the use of a loan to obtain capital or growth funds for a business startup. This kind of financing enables businesses to obtain the money they need without giving away equity. Provided businesses can keep up with the interest payments and pay off all that they owe, they will get to keep all the remaining proceeds in the future.
Sources of Debt Financing
You can obtain debt financing for your business from a number of sources. Some of them are outlined below:
- Private lenders: Private debt financing can come from lenders such as friends, family members, and relatives, colleagues, spouses, and private donors you can connect with to raise funds.
- Traditional lenders: Traditional lenders include banks that may advance financing in the form of business lines of credit, secured and unsecured loans.
- Personal financing: You can choose to obtain personal loans from traditional lending institutions. You can also use credit cards to finance your business using debt.
- Modern lenders: These include peer-to-peer lenders and payday loan lenders.
What to Consider Before Deciding on Debt Financiers
Here are the factors that you need to consider a before you obtain debt financing for your business.
You should sit down and determine how much your business will need to operate successfully. While it is a bad idea to get less financing than you need, it is also an equally bad idea to get much more than what your business needs.
The more you borrow, the more you will have to pay back. If you borrow money you don't need, you are likely to squander it. This may lead to a huge debt that may push your business into bankruptcy.
2. Interest rates
How much interest will you be expected to pay? Bear in mind that interest rates on loans tend to go higher depending on the amount of monthly payments you will have to make. This can interfere with your cash flow, which in turn may cause your business to stumble.
Try to look for debt financing offers with favorable interest rates. Do remember that those loans that you obtain without any security are more likely to have higher interest rates attached.
3. Your Options
With plenty of debt financing sources available, it is in your best interests to consider your options carefully.
For example, if you have a family member who is willing to advance you a loan for your business, consider the interest rates and the future implications. While the interest rates may be lower than the average, should your business fail, the relationship may suffer adversely. Are you willing to take on that kind of risk?
Benefits of Debt Financing
1. No equity giveaway
One of the biggest advantages of debt financing for startups is the fact that you will not have to give away a share of your business equity. This will enable you to maintain full control over your business.
2. No claims on future proceeds
Debt financing will only require you to pay the agreed-upon sum for as long as you owe the debt. Once your debt obligations are complete, you get to keep all of the proceeds without allotting any more to your lenders. Even if your business start-up is acquired for millions of dollars, the money is all yours as soon as you pay off what you owe.
Disadvantages of Debt Financing
1. Payment obligations
Even in difficult times, your lenders expect you to pay off your debt like clockwork. After all, they have no stake in the business.
2. Assumption of all losses
When you are the full owner of your business, all the risks are yours to take. Should you fail, you will need to assume not just your losses, but those of your lenders as well. Be aware that they can sue you if you can't fulfill your agreement.
Debt financing has its pros and cons. It is up to you to determine if this kind of financing for your startup will work for your needs.