Debt financing involves the borrowing of money whereas equity financing involves selling a portion of equity in the company.
What are examples of debt financing?
- Loans from family and friends.
- Bank loans.
- Personal loans.
- Government-backed loans.
- Lines of credit.
- Credit cards.
- Equipment loans.
- Real estate loans.
A big advantage of debt financing is the ability to pay off high-cost debt, reducing monthly payments by hundreds or even thousands of dollars. Reducing your cost of capital boosts business cash flow.
There are also several disadvantages with debt financing. The biggest one being you need to qualify. Also, the company and the owner must have acceptable credit ratings to qualify. And the business must be ready to do fixed payments, in that principal and interest payments must be made on specified dates without fail. This means businesses that have unpredictable cash flows might have difficulties making loan payments.
In debt financing, to calculate how much to lend, investors or lenders divide the company’s total liabilities by its existing shareholder equity. Both figures can be found in a company’s balance sheet as part of its financial statement. The Debt-to-Equity ratio shows clearly how much a company is financing its operations through debt compared with its own funds.
In which situation is debt financing advisable?
If equity financing is used to raise money from investors for business obligations, the investors may want a seat on the board of directors or may require that a percentage of ownership becomes theirs. If a business owner does not want to give up a portion of the control of the firm, then debt financing is preferable.
But be careful because although debt can be used as leverage to multiply the returns of an investment but also means that losses could be higher. Margin investing allows for borrowing stock for a value above what an investor has money for with the hopes of stock appreciation.
Whether your business is just starting up or preparing for expansion, debt financing can help support your short and long term financial goals. You will find there are a number of benefits to having different credit facilities, but before you apply, it’s important to determine whether your business is ready to take on more debt.
1. Review your credit history as a first step for loan success rate
Lenders will thoroughly examine both your personal and business credit history before making a credit decision. Before you approach a potential lender, request a copy of your personal credit report. If you find errors in your credit report, contact the credit bureau.
2. Gather financial documents for better loan success rate
You will likely need tax returns and financial statements for your business if you are applying for a term loan or line of credit. For a Small Business Administration loan, you may also need to present a formal business plan.
3. Determine how much capital your business for loan success rate
Before you walk into the lending office or fill out a credit application form, figure out exactly how much money your business needs to borrow, and make sure it’s a realistic amount. If you’re not sure how much capital to ask for, consider consulting a financial professional. He or she will closely examine your cash flow and current debt load to determine how much financing you actually need. Also, be prepared to tell the lender how you plan to use the money.
For example, you may explain that you will use the capital to pay for additional office space, furniture or equipment.
4. Understand all your lending options for better loan success rate
It’s important to identify all the lending options available to you and determine which one is the best choice for your business. You will also want to consider the process and the timing. For example, loan decisions below $100,000 may be based on your credit profile and basic information, while larger amounts may require a detailed review of your finances.
5. Consider payment terms as an important step for loan success rate
You also have to decide how long you will need to repay your credit. There are short-, medium-, and long-term loans, and they all have positives and negatives. For example, if you expect to be able to pay back the money quickly, a short-term loan may be the best choice.
While preparing to apply for credit, you’ll need to gather key information and required business documents to support your application. The requirements will vary greatly depending on the type and amount of credit, from basic information for a credit card to full financials for a major term loan.
For more complex loans, you may need to provide additional information. For example, in the case of a commercial real estate loan you will need to provide some property related documentation.
To present a strong business loan application and for better loan success rate, you should engage a loan specialist to help you avoid common application mistakes.