Debt Financing

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Definition

Debt financing involves borrowing money for your business, usually from a bank or friends and family in the form of a loan. This is the most common way for small businesses to get financing, because banks are more interested in smaller, lower risk investment opportunities. The main benefit to choosing debt financing (as opposed to equity) is that you will retain ownership of all of your business, which gives you the freedom to continue to run your business as you see fit without having to answer to an investor who may not have the same values that you do.

The main downside of debt financing is the reality that the money you are loaned has to be paid back, with interest, and you may have to collateralize the loan with assets, or personally guarantee that the loan will be repaid. Obviously this takes a bite out of your company’s profits, which can make it more difficult to grow because cash that you would otherwise invest into growth strategies must be used to make payments on your loan. Moreover, loans are usually paid back according to a pre-determined schedule, which does not necessarily account for the peaks and valleys that are likely to occur in your revenue stream. However, your interest payments are tax deductible, which can make the burden of interest payments easier to manage.