Figure: Debt Financing
The term "Debt Financing" refers to a situation in which a firm borrows money intending to repay it later with interest; this is known as debt financing. In both secured and unsecured loan situations, it is possible to get financing.
Here are some of the best debt financing options: -
1. Bank Loan
A bank loan is one of the common types of debt financing. Banks will often evaluate the financial status of each firm and provide loan sizes and interest rates that are appropriate for that circumstance.
2. Bond Issues
Bond issuances are yet another kind of debt financing. A classic bond certificate contains the following information: the principal amount, the time the repayment must be completed, and the interest rate. Individuals or companies that acquire the bond develop creditors when they debt money to the company.
3. Credit Card and Family Loans
In addition to taking out loans from relatives and friends, borrowing money using a credit card is another option for debt financing. They are quite frequent among start-ups and small firms, especially.
Advantages of Debt Financing
The corporation keeps complete control of its assets.
Paying down debt is often deducted from your taxable income
In many cases, debt financing is more affordable than equity financing.
Leveraging a small amount of cash for expansion is possible with debt financing.
The Drawbacks of Debt Financing
Lenders expect to be paid interest.
When debt has a set maturity date, it's important to plan.
Debt repayments must be paid regardless of company profits.
Businesses with variable cash flow should avoid taking on debt.
Examples of debt financing:
Lines of credit
Real estate loan
Home equity loans
Traditional bank loans
Loans from family or friends
Characteristics of Debt financing
From the viewpoint of the investor
Debt is often considered to be a low-risk investment because:
In many cases, it has a predetermined youth date, as well as the holder gets first dibs on interest or liquidation payments
The income is set; thus, the holder gets the same interest regardless of the company's profitability.
Debtor holders often cannot vote. Holders will only seize control of the firm if interest payments are missed.
From the viewpoint of the company
Debt is a low-cost investment. Loan noteholders are willing to accept a lower rate of return than stockholders since equity carries a greater risk. In addition, interest paid on debt is deductible from taxable income.
Types of Debt Financing
Loans From Financial Institutions
Small and middle-market companies have a difficult time obtaining bank loans. Traditional financial institutions, after all, are one of the most prevalent sources of loan financing. Historically, successful companies have a higher likelihood of receiving bank loans.
Loans From a Friend or Family Member
Starting a business using family loans may be risky, especially if you don't have a clear strategy in place for repaying the money you borrowed from family and friends.
Home Equity Loans
The home equity loan is simpler than a standard bank loan if the borrower has equity in their property and excellent credit. As with a mortgage, home equity loans are one-time cash infusions with a predetermined monthly repayment rate.
By summing up, debt Financing involves providing money to execute the commercial activity, while debt refers to the amount owing and due. One of the most important parts of debt financing is maintaining control over the company. Providing fixed income instruments like bonds, bills, or notes are referred to as debt financing when done by a firm. When a company uses debt financing, it borrows money instead of issuing stock.