There are primarily two ways that businesses can fund their operations: equity financing and debt financing. These two models offer drastically different paths to financing, each with its own pros and cons. However, we’re here to provide you with the information needed to take advantage of debt financing for your business.
We’ll give you a comprehensive guide to equity financing, including various loans, lines of credit, SBA opportunities, and more that you can utilize for success. Choosing the right debt financing option can be a tough decision, but hopefully, this manual gives you the insights needed to reach your business goals.
The Basics of Debt Financing
So, what exactly is debt financing? Well, when a business borrows money and pays it back with interest — that’s the basic formula of debt financing. However, there are many different types and structures that this lending operation can come in, such as:
Business term loans are where a business owner borrows a set amount of cash upfront and pays it back with interest depending on the term of the loan. These business loans will have fixed payment schedules depending on the type and could also be secured or unsecured.
Cash flow loans refer to advances that rely on your earnings. While traditional loan structures have you paying back over a fixed schedule, cash flow loans come out of your revenue in the form of lender’s fees. Merchant cash advances, business cash advances, and invoice financing are some of the most popular types of cash flow loans.
Business lines of credit are revolving “loans” with flexible opportunities for business owners. It works similarly to a credit card, where you can pull funds up to a specified limit and pay interest on what you borrow. It’s a sound solution for a wide range of industries and businesses that need a more flexible solution.
Where Can I Find Debt Financing?
If you’re looking for debt financing, you have a wide range of sources to consider. While some options may offer more attractive terms, others could be a sound solution for business owners struggling with debt financing requirements such as credit scores, time in business, and financial documentation.
Here’s where you can look for debt financing today:
- Credit unions
- Online alternative lenders
- Peer-to-peer lenders
- Nonprofit lenders
- Merchant cash advance companies
Alright, now that you have a better understanding of what debt financing is and where to find it — let’s break down some of your best options so that you can make the right decision come lending time.
What Are the Pros and Cons?
There are many positives and negatives to consider when looking at debt financing options for your business. Let’s go over some of the advantages and disadvantages so that you can be more informed and make the best decision possible.
The Pros of Debt Financing
While equity financing offers many benefits, you lose some control of your business — which many business owners aren’t too excited about. With debt financing, you keep control of your enterprise without having to offer up any freedom or power. Plus, you have a wide range of options to choose from, each with pros and cons of their own for you to consider to reach your business goals — which we’ll get to later on in this post.
- You receive tax advantages when you utilize debt financing. The interest rates on your loans are tax-deductable, whether you’re an S-corp, sole proprietor, partner, and more. Other fees associated with many loan products are also tax deductible, like origination fees.
- You can build business credit while paying back your loan. Building your credit score is crucial for all business owners, and we have put down some tips for how you can boost your business credit score through debt financing.
- It’s easier to obtain compared to equity financing. The simple truth is that debt financing has more options, which gives you more freedom and flexibility to find options that work for you — and that you’ll qualify for. Equity financing can be difficult to obtain with such a competitive pool for funding.
The Cons of Debt Financing
Like with any financing opportunity, there are disadvantages too — and debt financing is no exception. Whenever you’re weighing loan options or funding solutions, it’s all about finding what works for your business rather than against it. Here are some cons we want to point out.
- You could risk business assets if it’s a secured loan. If your assets aren’t enough to qualify, you may have to sign a personal guarantee which could put your own assets at risk.
- Some debt financing options may negatively impact cash flow if you’re not careful. This typically happens when a business owner doesn’t fully calculate how monthly payments, fees, or deductions impact their bottom line.
- Newer businesses could struggle with some of the more attractive debt financing options out there — as these require longer time in business or solid business credit.
Our Top 7 Choices For Debt Financing
1. Short-Term Loans
Starting off the list are short-term loans, a lump sum of upfront capital with a fixed repayment period (6-18 months) that a lender provides for a wide range of business needs. Whether it’s working capital, business purchases, expansion, renovations, and more — short-term loans can be a great option for businesses that may not qualify for loans with more rigid qualifications. If you’ve never sought out debt financing before, this is a great first step to see what you’re able to manage for your business. If you want to learn more about qualifying for short term business loans, take a look at our step by step process.
2. Long-Term Loans
Similar to its short-term alternative, long-term business loans can be used for a wide variety of needs such as working capital, equipment purchases, business expansion, etc. However, the primary difference is in the repayment schedule and qualifications, where repayment terms can be anywhere between 2 years and 25 years. With a fixed or adjustable interest rate and principle along with monthly or bi-monthly payments from a business bank account — long-term business loans are for more established businesses with sound financials. Credit score requirements are also higher due to the amount of money and lengthy terms.
3. Business Lines of Credit
For businesses looking for more flexible and revolving financial options, a line of credit is a great solution. As mentioned, these resemble credit cards — as you can draw cash up to a certain limit and only pay interest on what you take out. There are also secured options for business lines of credit, which are secured by assets like real estate, equipment, IP, and more. There are also unsecured lines of credit, but these come with higher rates. You can look for business lines of credit from banks, credit unions, online lenders, and even go through the Small Business Administration (SBA).
4. Invoice Financing
Also known as invoice factoring, invoice financing gives businesses with outstanding payments the chance to keep up cash flow. You get an instant of around 80% of the outstanding invoice through invoice financing, with the remaining 20% being returned later on (minus factoring and applicable fees). This is one of the primary forms of asset-based loans (ABLs) or accounts receivable financing that business owners who rely on client payments can take advantage of for instant cash flow.
5. Cash Advance Options
Both merchant cash advances and business cash advances are simple debt financing options that provide cash in exchange for a percentage of future company sales. These agreed-upon percentage deductions are automatically drawn from daily sales.
- Merchant cash advances refer to deductions from daily credit or debit card sales.
- Business cash advances refer to deductions from overall daily sales.
If you need cash flow fast, these can be a great solution — especially if you have limited time in business or poor credit history. However, we recommend having a robust strategy for your next debt financing option. While it’s an extremely popular option for small business owners looking for a loan, these advances can dig into your business sales and be an expensive option compared to other funding solutions.
6. Equipment Financing
Many industries rely on expensive equipment for their daily operations and overall success, but having cash on hand to purchase necessary equipment is easier said than done. Whether it’s a new technology, vehicles, machinery, and more — equipment financing is a fast and efficient way to get the funding you need today. The equipment you plan on purchasing acts as its own collateral, which actually boosts your approval chances compared to some other forms of debt financing. Manufacturing companies, restaurants, healthcare industries, and beyond can benefit from equipment financing options.
7. SBA Loans
The Small Business Administration offers a wide range of loan programs for business owners like you. Now, the SBA is not the lender but rather a federal entity that offers guarantees lenders that you can take advantage of if you qualify. We say this because it can be tough to get aprproved for many SBA programs, with such rigid requirements for qualification. Failing to qualify for an SBA loan can be devastating, but we have some tips for managing SBA loan denial.
These loan programs come in all shapes and sizes and can be a great way for small business owners to access the funding they need with attractive terms and rates. Here are some of the most popular options:
The 7(a) Program is the most common SBA loan option, with debt financing solutions of up to $5 million. These loans can be used for a wide range of business purposes too — giving you a flexible program with great rates.
The SBA Microloan Program offers smaller amounts of funding, between $500-$50,000, for younger businesses that need some help in the early stages. This is a popular SBA option for startups that are looking for capital to keep up the momentum.
The CDC/504 Program is for major purchases on fixed assets like real estate, land, expensive equipment, or significant renovations. These loans can be up to $5 million with longer repayment terms of up to 20 years.
Discover Your Debt Financing Solution Today
With so many lending options for business owners to choose from, there’s a lot of research to be done. We hope that this comprehensive manual gave you the insights you need to start your journey in debt financing for your business. Regardless of the business’s health or success, nearly every business owner will need some form of debt financing during their company’s lifespan — so knowing what solutions are available and where to find them is critical in succeeding in enterprise.
Whether you need flexible solutions like business lines of credit or more substantial capital from long-term loans and SBA programs, you have options.