That is why it is essential to comprehend the benefits and drawbacks of debt financing. It is said that it “needs money to make money,” but it is also required to be able to “borrow inexpensively” to be successful.
The question then becomes which source of funding to seek to establish and expand its business: while there are many alternatives, we will focus on the bank loan here.
Debt financing is borrowing money from a moneylender or a bank to raise capital. Creditors must pay interest on borrowed funds in exchange for a loan.
Debt can be paid off, allowing small firms to stockpile merchandise, hire more employees, and buy real estate or equipment.
Benefits
One of the most practical benefits of debt financing is that you retain control of your company. When you accept a loan from a financial institution or an alternative lender, you must make timely payments throughout the loan.
On the other hand, suppose you give up ownership in the form of shares in exchange for funding. In that case, you are giving up a portion of your restaurant or business to an outside entity, who can then influence the future of your business based on their investment. It isn’t the best option if you want to be the sole master on board.
You benefit from tax deductions
Deductions from taxes are a significant advantage of debt financing. You can deduct this debt’s principal and interest payments from your business income taxes because it is classified as a business cost.
Low-interest rates are available
Credit cards, peer-to-peer loans, short-term loans, and other debt financing options may not be beneficial if interest rates are incredibly high. You can, for example, use bank rate comparators to compare the various interest rates offered by different banks.
You develop your credit history
Lack of financing or insufficient operational capital is one of the leading causes of business and restaurant failure.
If you want to get long-term, low-cost debt financing, you’ll need a good credit history. As a result, the chance to improve your business credit history is a significant benefit of taking out a loan.
Long-term debt can eradicate reliance on expensive debt
Specific lenders employ high-pressure sales tactics to get firms to take up short-term loan advances. It’s not unusual for firms in desperate need of cash to take out five or six cash advances in a run.
This method can trap a borrower in a never-ending debt cycle. To prevent becoming trapped in a cycle of constant borrowing, search for a loan with low-interest rates, long periods, and affordable monthly payments.
Disadvantages
You must reimburse the lender (even if your business goes bankrupt)
The guidelines for operating with a lending institution are relatively straightforward. You must refund the loan according to the terms agreed upon, and it means you must make payments even if your company goes bankrupt. Because most lenders require collateral, you may liquidate your assets to repay your obligation.
High rates
Predatory lenders exist, and their methods for luring naïve small company owners are becoming more sophisticated.
Some unethical lenders utilize measures other than the APR (annual percentage rate) to hide the exact cost of a loan. Although this tendency is not specific to debt finance, it is worth noting. Work with a lender who is evident and provides you with accurate information. Know your loan’s APR and payment and compare them to the original sum.
You will need a guarantee
Collateral is one of the “5 Cs” of lending, described as a secondary source of loan repayment that you can utilize to ensure the lender.
If a bank may sell an asset for cash, it is considered collateral. Equipment, structures, and (in some situations) goods may be deemed enough collateral.
Collateral helps lenders mitigate risk and is required for many types of loans. The quantity of collateral a borrower must furnish is usually proportional to the loan amount. Some borrowers consider this to be a disadvantage.
If you’ve concluded that more money will help you grow your company, you should think about the advantages of debt financing.
All debt is the same. So, work to keep your credit score high to acquire the best interest rate and more extended payback periods, which will boost your chances of staying in business.
If debt financing is one of your options for expanding your company, you’ll need a versatile and adaptive checkout solution to handle your point of sale and save money over time. Contact our experts right away to learn how Lightspeed can assist you.
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