It is common knowledge in the business circle that those who have access to credit lines are in a better position to start successful businesses than those who do not. Before we even go deeper with the aspect of advantages of debt financing over equity financing that come with debt financing, we already have an idea of how important a role debt financing plays in our daily lives.
In the previous article where we looked at the types of debt financing, we touched on a couple of ways in which loans can be given out and how they can be paid back as well as the connotations involved.
However, we did not exhaust all the types that exist because research keeps revealing more, such that we may end up with a book instead of just an article.
Reflecting on these, I have decided to approach the list of advantages of debt financing from more of a personal evaluation angle rather than the set academic list. To make this worthwhile, we will use examples and cases from the types we did not get to familiarise with in the previous discussion to exaplain advantages of debt financing over equity financing.
Let us establish these advantages together and see what we come up with:
What are advantages of debt financing?
The main advantages of debt financing is that it provides acceleration of business startups, ensures Businesses Resuscitation, Presents Opportunities for Expansion, Creates New Partnerships and Saves Time. Another advantage of debt financing is that the creditors look favorably upon a relatively low debt-to-equity ratio. This in return benefits the company if it needs to access additional debt financing in the future.
1. Acceleration of Business Startups
So many brilliant business ideas go to waste because of lack of financing and in some cases these minds have no access to startup funds what so ever. We can start mentioning a lot of businesses that were started with money obtained through debit financing. Some of them have bee grown into large corporations that employs a number of families.
One type of debt financing that stands out for me in serving this purpose is ‘Credit card.’
These have been used by business owners for a very long time to build their businesses. Usually business owners use cards from future lenders and win their trust.
“Small business credit cards are guaranteed personally through the buyer, meaning that established business credit isn’t required to use one. Many come with favorable introductory offers, such as 0 percent APR for the first year.”
2. Businesses Resuscitation
Business is not just coming up with products/services to sell, get your money and leave. Rather it is an intricate phenomenon that needs you to do a lot of planning and exercise due diligence too when working around the dynamics. I don’t think there’s any business owner who can stand and say, “My business never encountered a loss from the time we opened doors right up to when the business grew into a household name.”
Now the question is what to do in a case of huge losses. Some losses can not be saved by insurance. You actually have to source for a loan to resuscitate your business. Not only companies need saving from dire financial situations, government agencies and other agencies do this too. This brings me to an interesting type of debt financing that can help this situation better than a loan.
This is the use of ‘Bonds,’ which are loans where, “capital comes from those investors who buy bonds from the company or organization. That company then pays out interest regularly — normally every six to 12 months — and when the bond reaches maturity, returns the principal.”
3. Presents Opportunities for Expansion
There comes a time when a business has been trading for a long time but with very slow growth or sometimes no growth no loss, just stagnant. When business owners start their trades, the common goal is to grow into a recognisable corporation and debt financing is the quickest go to source of expansion funds.
Investors and lenders are also interested in putting money on businesses that have been trading for a long time and built a reputation. I would say the perfect type and advantages of debt financing for this cause is ‘Debenture’ which is similar to bonds but with the slight variation that the former is backed not by collateral but rather, relutation. Despite this being a risky type of debt financing, the potential rewards are high.
Another advantage, to the lender of course, is debentures come with high interest rates as compared to general bonds.
Here is how debenture works, “As with bonds, the borrower issues an indenture to the lender, outlining the details of the loan, maturity date, interest rate, etc. While the terms vary from one debenture to the next, they typically run longer than 10 years.”
4. Creates New Partnerships
‘No man is an Island,” goes the famous old riddle. When you treat your businessike a man, you will realise for him to flourish, you need partnerships and support from others. Debt financing is one such way of forging new partnerships with individuals as well as other businesses.
You may be wondering how this is possible but earlier we heard in the use of credit cards that business owners use these for a long time and earn the trust of future lending associations. This is a way of creating a partnership which is in this case beneficial to the borrower once he secures a good reputation with the lender.
5. Saves Time
Working and hustling for a huge amount of money to either startup a business or explore an expansion idea can be time consuming and exhaustive too. Some potential investors may not have all the time to wait for you as you set up your business, competitors may be moving and dominating the market you want to enter, and more other factors where time is the determinant of whether or not your business or expansion project will succeed.
Business owners who have access to solid debt financing do not have to lose sleep majoring in the minor. If your business meets all requirements to secure a loan that suits it best, a lot of time is saved by simply applying for one.
However, self evaluation remains a fundamental aspect in all these loan considerations. You need to make sure you have a clear outline of how you intend on paying back the loan and make sure you use the loan only for your business’ needs.
There are a myriad of advantages of debt financing but for the purposes of this article I decided to doctor my own based on the common desires that we chase business men and women. Maybe one big advantages of debt financing over equity financing that almost everyone looks at reluctantly on the part of the lenders is interest that accumulates on loans, but this is not the only advantages of debt financing.