The Pros and Cons of Debt Financing for Small Businesses
When a small business owner needs additional funding to operate their business, they often turn to outside financing sources. While putting in the owners’ money is always one option, securing debt financing is a common practice. Before taking on this type of financing, small business owners should understand some of the benefits and downsides of this choice.
Financing Through Debt Defined
In the most straightforward terms, this type of financing is when a small business borrows money from outside of the company for the operation of the small business. The business owner is usually responsible for paying back the principal plus some set interest. There is typically a repayment schedule set up when the financing occurs.
While the traditional route of going to a bank is often a way that a small business can secure financing, there are also plenty of other choices that a small business owner should consider. A small business owner needs to understand each type and the pluses and minuses of all kinds of finance.
Some of the Reasons a Small Business May Use Debt Financing
For a small business that is growing quickly, financing through debt is often the best way to get immediate capital into the company. One of the benefits of financing over owners putting more money into the business is that the interest on the financing is tax deductible.
Another reason a small business may use that financing through debt is that they have short-term financing needs. Getting loans with maturity dates that are less than one year is often a very cost-effective way to bridge the gap of any short-term capital needs.
One other reason a small business owner may use financing through debt is that when they do, they maintain control of the business. When small businesses turn to current or new owners for capital, they often give up substantial control of their business.
The Benefits and Drawbacks of Debt Financing
Beyond the advantages of the tax deductibility of financing through debt interest payments and keeping control of a business, financing through debt often comes at a much lower interest rate. The additional benefit is that there are quite a few more options making financing easily accessible for small businesses. When small businesses acquire financing, they also improve their business credit score.
Some of the disadvantages of this type of financing are that repayment needs to get done as part of the loan, which can substantially impact the company’s cash flow. Another issue is often finding enough collateral to back a loan.
Financing through debt, when done well, is an excellent way for a small business to acquire capital. It offers plenty of advantages to a small business that makes a great choice on many levels.
