New and growing businesses often need funding to get established and take their product or service to the next level. Financing a business can seem like a daunting task and is one of the greatest challenges for entrepreneurs. There are two basic forms of financing for business start-ups or expansion – typically either debt financing or equity financing. We are going to break down business financing options in this two part blog series to help business owners, and prospective entrepreneurs, navigate this complex issue. In this first part of our series, we are talking about Debt Financing.
At R & F Commercial Debt and Equity we are experts in Debt financing. This is what you would consider a loan. A creditor lends money to an individual who agrees to repay the loan amount with interest over a designated period of time. The lender does not take any ownership in the business. Debt financing is a good option for business owners who do not want to give up ownership interests in their business. Another benefit of debt financing is the interest on the loan is tax deductible. The cost of the loan repayment is a fixed expense, meaning each month the obligation is the same and can easily be calculated into the budget.
Debt financing may be short-term, where the repayment of the entire amount is due in less than one year. Long-term options are also available, where the amount is due over a period greater than one year. Personal guarantees may be required, especially from smaller businesses. This is where the lender requires all parties with ownership, and their spouses, to sign an agreement to pay any outstanding amount on the loan. All parties are personally liable for the entire amount of the loan, regardless of their percentage of ownership. This is the case, even if the business is a corporation. Business financing is, in fact, personal debt.
It is important to choose a lender that is a good fit for your business. There are several options available for securing a business loan – banks, credit unions, consumer finance companies, and commercial finance companies. R & F Commercial and Debt Equity is a non-traditional form of business funding, offering yet another option for business funding. There are different types of loans as well. You may need to secure your loan with collateral, in the form of a house or other high value items. If the loan is not paid, the lender has a legal right to take possession of the collateral.
Debt-to-equity ratio is one of the important factors that lenders look at when evaluating a business for funding. This measures the amount of available assets or “cushion” that could be used for repayment of the loan in the event that it defaults. Lenders generally want to see 1:1 or 1:2 debt to equity ratios when granting funds. This is an indication that the business is being run in a responsible manner. Lenders also look at individual credit history, collateral, cash flow, and character to determine if the prospective business owners present a good risk.
Too much debt financing may have a negative impact on your credit rating and your ability to raise more money in the future. If you have too much debt, your business may be seen as overextended and too risky an investment. Also, with too much debt, it may be difficult to survive unexpected bumps in the road, such as economic downturns.
In contrast to debt financing, Equity Financing refers to money given to a business in exchange for a share of ownership in that business. With equity financing the business owner does not incur debt, but sacrifices some aspect of ownership or control over his business. It can also simply be financing that does not have a lien, like when you put a downpayment on a home, you only finance the remainder and you have the downpayment as “equity” in your home..There are various arrangements for this kind of funding and we will go into more detail in our next blog.
Debt financing is one way to secure much needed funding for business start-up or expansion. The other avenue, equity financing, will be the focus of our next blog. At R & F Commercial and Debt Equity, our significant experience in this arena sets us apart from the others. Contact us for more information on different financing options.