What is Debt Financing?
Debt financing is a means of raising funds to generate working capital that is used to pay for projects or endeavors that the issuer of the debt wishes to undertake. The issuer may choose to issue bonds, promissory notes or other debt instruments as a means of financing the debt associated with the project. In return for purchasing the notes or bonds, the investor is provided with some type of return above and beyond the original amount of purchase. Debt financing is very different from equity financing. With equity financing, revenue is generated by issuing shares of stock at a public offering. The shares remain active from the point of issue and will continue to generate returns for investors as long as the shares are held. By contrast, debt financing involves the use of debt instruments that are anticipated to be repaid in full within a given time frame. With debt financing, the investor anticipates earning a return in the form of interest for a specified period of time. At the end
Debt financing refers to borrowing money from a source outside the company under certain terms and conditions relating to interest rate and the period of return of the principal amount. Most entrepreneurs prefer to start their operations with the money borrowed from banks and financial institutions. But this does not mean that large corporates are averse to taking loans. In fact, most big businesses have a debt component in their balance sheets, the reasons for which could vary from tax breaks, low interest funding or big acquisitions. But the option of debt financing may not be open to some sectors at all. For instance, startup technology companies. This is because they have no assets to offer as collaterals. According to Jayant Tewari of Outsourced CFO and Business Advisory Services, “in the technology space, debt is fundamentally not available. This is because there is no asset base that can be securitized as most firms operate out of rented premises. The only asset they can lay cla
Debt finance could usually be short term or long term. Debts are repaid over a period of time, at fixed or variable rates of interest. The lender has no equity stake in the company although a lender may require the ability to convert debt into equity on the occurrence of certain events. The lender will usually require that the debt be secured by a business or personal asset. Terms can vary in length from one year to 25 years, and will usually be determined by the asset that is being financed. The interest rate will reflect the lenders perception of the risk in providing the debt. Short term Debt financing can be provided in the following ways: 1. An overdraft is money that a business can borrow from a bank up to an agreed limit. It provides a business with short-term financing, effectively by running a negative balance on the bank account. This is a particularly good way of funding short-term requirements, such as providing working capital during the course of each month. 2. Term loan
Debt financing is borrowed money expected to be repaid over a specified period of time. WHAT IS A LENDER LOOKING FOR? Lenders look for three things when determining whether or not to loan you money: * Cash Flow – Previous profitability of your business and its industry and market information that predicts future profitability. * Collateral – a second source of repayment, most often personal or business assets. * Credit History –Your personal credit is a strong indicator of how likely you’ll repay new debt and obligations. WHAT ARE MY OPTIONS? * Traditional BANK lenders: Many banks use special loan programs such as the Small Business Administration Loan Guarantee Programs, the State of Illinois loan programs, and the City of Chicago loan programs * Microlenders in the Chicago area * Non-bank financing, such as Accounts Receivable financing programs (Factoring), and PO Financing. (See Glossary for definitions of these and other business terms.) and equity financing. NEXT STEPS: 1. Read C
