What Is Debt Financing?

Debt financing involves borrowing money from lenders who offer debt instruments with the promise of repayment with interest over a specified period. This method allows businesses to acquire funds without relinquishing ownership or control of the company, unlike equity financing, where shares are sold in exchange for capital.

The Types of Debt Financing

Loans

Small business loans are one of the most common forms of debt financing. Depending on your choice of lender and the amount of capital you need, you'll want to consider the interest rates, repayment duration, and terms of any loan offerings you qualify for to build your business.

Bonds

Larger corporations may issue bonds to raise capital from investors. These bonds promise regular interest payments and repayment of the principal amount at maturity. Bonds can be publicly traded on financial markets, offering liquidity and flexibility.

Credit Cards

Most business owners should consider credit cards second nature. They are readily available and can occasionally garner users' rewards. That said, credit cards can come with a high degree of risk, especially if your business cannot afford to cover monthly payments or if the interest rates are significant.

Lines of Credit

Lenders sometimes offer lines of credit based on your ownership of something with significant collateral, such as a home or a business. The amount of funds available to you may be subject to change depending on how much ownership you personally have in a business, and there are both withdrawal and repayment periods to consider when pursuing this type of debt financing.

The Advantages and Disadvantages of Debt Financing

The benefits and drawbacks of debt financing vary depending on the type of debt instrument utilized, but there are a few overarching themes within all of them.

Benefits of Debt Financing

• Maintaining Control: Unlike equity financing, debt financing allows businesses to retain ownership and decision-making autonomy.
• Tax Deductions: Interest payments on debt are often tax-deductible, reducing the overall cost of borrowing.
• Predictable Repayment: Fixed repayment schedules provide clarity and help businesses manage cash flow effectively. 
  
• Building Credit: Successfully managing debt obligations can improve a company's creditworthiness, making future borrowing more accessible and cost-effective.

Drawbacks of Debt Financing

While debt financing offers significant advantages, it's essential to consider potential risks:

• Interest Costs: High -interest rates or variable rates can increase borrowing costs, impacting profitability.
• Debt Service: Obligations to repay debt must be met regardless of business performance, adding financial pressure during downturns. 
  
• Collateral Requirements: Securing debt with assets can limit flexibility and pose risks if repayment becomes challenging.

To help you reach your business objectives, BHG Financial offers specially tailored commercial financing of up to $500,0001,2. Depending on your needs, you may qualify for repayment terms of up to 12 years1, and you can use the capital gained to expand your operations, buy out a partner, or purchase or lease equipment, and more. You can rely on our dedicated, U.S.-based concierge six seven days a week to serve your needs along the way.

It only takes 30 seconds to view your personalized estimate using our payment estimator. 

How do lenders evaluate a company's eligibility for debt financing?

Lenders typically assess factors such as the company's creditworthiness, financial performance, cash flow projections, collateral (if applicable), and the purpose of the loan.

When is debt financing appropriate for a business?

Debt financing is suitable when a business needs capital for specific projects (such as expansion or equipment purchase), has predictable cash flow to service debt, and wants to retain ownership and control.

What should businesses consider before pursuing debt financing?

Businesses should evaluate their ability to service debt, understand the total cost of borrowing (including interest and fees), and assess the impact on cash flow and overall financial health.

How can businesses minimize the risks associated with debt financing?

Strategies include maintaining a diversified funding strategy, monitoring cash flow closely, having contingency plans for economic downturns, and negotiating favorable terms with lenders.

Can debt financing be used for short-term needs as well as long-term investments?

Yes, depending on the terms and purpose of the loan, debt financing can be structured for short-term needs (like working capital) or long-term investments (like infrastructure or technology upgrades).