Debt financing refers to the borrowing of funds from sources outside a business in order to raise money for capital or other business expenditures. This money can be borrowed from banks, private investors or even family. These lenders become creditors, with a promise that the debt, as well as interest, will be paid back in full. Debt financing can be a good option for many reasons.
Many fledgling companies do not have the capital to fund their start-up costs. As a startup business, it can also be difficult to secure a business loan without an established credit history. By borrowing capital from sources outside the company, a business gains the chance to create positive cash flow. The terms of the loan are agreed upon by the parties involved and must be re-paid at the time specified.
Money borrowed through debt financing is considered a business expense and qualifies as a deduction for the business’ income taxes. In most cases, both the principal and interest of the loan can be used as a tax deduction. This is very attractive to the business borrowing the funds.
Lower Interest Rates
With debt financing using outside sources, it is easier to negotiate a lower interest rate. The interest rate can be whatever amount that is agreed upon by both the borrower and lender. A lower interest rate, coupled with a business tax write-off, means benefits that are hard to beat. The lender is happy as well, as they will most likely earn more interest through debt financing than from many other investments.
As you can see, debt financing can benefit a business in several ways. Whether one owns an established business and needs funds for unexpected expenditures or equipment, or is a startup company in need of a positive cash flow, debt financing can provide a workable solution.