When you borrow an amount of money from some outside source promising to return not only the principal amount but also an additional percentage of interest as per agreed terms of a contract, you are actually taking a debt. The term debt often has negative implications. However, debts could be pretty useful for business owners, especially, small startups often are in need of debt for financing their operations effectively.
In reality, even the healthiest of all corporate balance sheets would be typically including a certain level of debt. Debt is regarded as leverage in terms of finance. People mostly rely on banks for debt financing but there are many reputed private companies, family members, or even friends who could act as a valuable source of debt financing for your business.
Explore the Pros of Debt Financing
Maintain Ownership Despite Debts: When you are borrowing some money or in other words, acquiring a debt from a lender or the bank, you would be obligated to fulfill all agreed-upon repayments as per the schedule. However, you still retain your right to operate your business in whatever manner you choose without any fear of outside pressures or interference of any kind.
Tax Deductions: This could be an immense attraction for seeking debt financing. Mostly, the interest payments along with the principal on a certain business loan are actually classified precisely as business expenses. Hence, they could be deducted effectively from the income of your business during tax time. It really pays to regard the government as your partner in the business with certain percentage ownership depending on your rate of business tax.
Lower Rate of Interest: You must consider analyzing the effect of tax deductions on your bank rate of interest. Suppose the bank is actually charging 10% of your loan while the government is taxing you at a rate of 30% then there is a definite benefit of considering a loan that you could deduct.
Know the Cons of Debt Financing
Repayment: Your only obligation to your lender is to make timely payments. Moreover, you would still require carrying on with the repayments even though your business flops. Your lenders would be having a definite claim to repayment if you are compelled into bankruptcy. You may seek professional assistance for perfect debt relief solutions.
High Rates: Even though the discounted rate of interest is calculated from the tax deductions, you would still be encountering a high rate of interest as these would be varying with macroeconomic conditions, personal credit history, business credit history, and your history related to the bank.
Impacts Credit Rating: It may seem to be quite an attractive proposition to opt for debts when funds are needed by your business, but with every loan, there would be an impact on your credit score or credit report.
Cash plus Collateral: Obviously, you would be taking a loan for investing in a really important asset but then you need to be doubly sure that your startup would be able to generate an adequate cash flow for meeting loan repayment on time. In all probability, you would have to put up collateral for protecting the lender if in case you would be defaulting on your payments.
Starting any business would necessitate money. Fortunately, you have access to several options for borrowing money even if you do not have the money right now, provided you have a fabulous idea to execute. Debt financing would be allowing you to borrow some money from an institution or a person. You have learned the pros and cons of debt financing, it is now your decision whether to seek debt financing or not, as per your requirements and preferences.