Funding is important from a startup’s early beginning to its journey toward initial public mergers, acquisitions, or offerings. In the early stages, such as pre-seeding or seeding, entrepreneurs often invest their capital. However, as the business gains momentum, it becomes necessary to seek external sources of funding. Opting to raise funds from the market opens up numerous options, including debt financing, to fuel the growth and development of the startup.
Learn more about debt financing.
Debt financing refers to a form of funding extended to startups by investors or lenders, such as banks, for a specified period. It resembles a conventional loan arrangement, where the startup borrows a certain amount of money and repays it along with interest. The primary objective of debt financing is to assist startups in extending their financial runway in between equity financing rounds. Here, we outline some typical advantages and disadvantages of debt financing, empowering you to make well-informed decisions for your business based on your current circumstances. However, if its your first time then it is better to get yourself wise advise from Joseph Stone Capital.
Why debt financing is beneficial
A significant benefit of debt financing is the tax deductions it offers. As a business expense, the interest and principal payments on the debt can be deducted from your business income taxes, resulting in reduced taxable income.
Debt financing offers the significant advantage of retaining ownership of your business. When obtaining a loan from a financial institution or alternative lender, the sole obligation is to make timely payments for the duration of the loan. This means that you are not required to give up any ownership stakes in your business.
Another advantage of debt funding is the flexibility it offers in utilizing the raised funds based on the founders’ and business needs. Unlike equity financing, where funds are often allocated for specific purposes, debt financing allows greater freedom in allocating funds without interference from investors. This enables the founders to have more control over the decision-making process and the utilization of the funds as per the business requirements.
High-interest rates on credit cards, peer-to-peer lending, short-term loans, and other forms of debt financing can be detrimental to your financial situation. However, there is a positive aspect to consider. Small Business Administration (SBA) loans present an excellent opportunity for accessing low-cost funds, making them a favorable option for businesses.
Having excellent business credit is essential when seeking low-cost, long-term debt financing. Therefore, the ability to establish and improve your business credit is a significant advantage to taking out a loan. By building your small business’s credit score, you can reduce the need to rely on your credit or other costly business financing options. A good business credit score can help you negotiate more favorable terms with suppliers and lenders.
Securing debt financing for startups can be a challenging endeavor. Therefore, prepare essential financial statements before embarking on the process. At a minimum, startups should have a forecast, business plan, profit and loss statement, and balance sheet to provide a clear overview of intangible and tangible assets to the lender. These documents help demonstrate the viability of the business and enhance the chances of successfully obtaining debt financing.
Startups might look for capital from non-bank lenders, even though banks are often a source of debt finance. It’s crucial to remember, though, that non-bank lenders could have higher interest rates than banks. In such cases, Joseph Stone Capital can be a valuable resource, providing high-level financial data that investors and lenders prioritize and consider significant.