Everything You Need to Know About Debt Financing

Starting a business and running it smoothly needs a lot more than a great, unique idea. Adequate funding is one of the most basic requirements of any successful business. From asset purchases to staff payments, cash flow management to business expansion, there are several things you need money for. Nowadays, businesses have plenty of options to get quick access to funds, and debt financing is one of them.

Table of Content

• What is Debt Financing?
• Types of Debt Financing 
• Advantages Of Debt Financing
• Diversification of Funding Sources

What is Debt Financing?

Debt financing can be defined as the process of raising working capital by issuing debt instruments. It is a popular alternative to equity financing, where businesses acquire funds by issuing shares. Debt financing is a suitable option when a business owner wants to arrange money without having to give up equity.

This is somewhat similar to a traditional loan and comes with an obligation to repay the borrowed amount after a predetermined period. In addition to this, debt financing also incurs interest, which is often called the cost of borrowing.

Types of Debt Financing

There are several different forms of debt finance, and each one of them comes with its own set of advantages. These options are designed to meet the specific financial needs and circumstances of business owners.

Business Loans

Traditional business loans are one of the most commonly used types of debt finance. Currently, a large number of lending institutions are offering quick and hassle-free business loans at highly competitive interest rates. You can choose between fixed and floating interest rates and easily borrow money to meet various financial requirements of your business.

Corporate Bonds and Debentures

Many businesses opt for this form of debt finance to raise working capital. They issue bonds that can be purchased by investors. Those who purchase these bonds are called creditors, who essentially lend money to the business. These corporate bonds are valid for a predetermined period. The business owner pays interest at a regular interval and repays the principal amount upon maturity of those bonds.

Convertible Notes

This type of debt financing is commonly used by startups and early-stage businesses. These notes are usually issued for a short period, and after that, they can be converted into equity.

Lines of Credit

When a business wants to get quick access to funds for small expenses, securing a line of credit is considered a suitable option. This type of debt financing gives you access to a predetermined borrowing limit, and then you take the money as per your requirements. The best thing is that interest is paid only on the amount you actually borrowed and not on the entire limit. Maintaining timely repayments on a line of credit can also help improve your CIBIL score, making future borrowing easier and more cost-effective.

Factoring

Factoring is also a popular form of debt finance that caters to the short-term financing needs of businesses. In this option, an enterprise can choose to sell its accounts receivable to another party and quickly obtain the required funds. It allows you to borrow money for a shorter duration and comes with better flexibility.

Suggested Read: Business Loan for MSME: Eligibility, Process & How to Apply

Advantages Of Debt Financing

Here are a few key advantages of debt financing:

Tax Savings

The interest that you pay on debt finance is considered a tax-deductible expense. This reduces the overall tax liability of your business. You can claim the tax deduction on your interest payments while filing the annual ITR.

Ownership Retention

Equity financing is a popular financing option for businesses, but it requires you to give some shares to the person/institution that is providing your funds. But in debt finance, you can retain the complete ownership of your business if you repay the complete amount (principal + interest) within a predetermined time period.

Flexibility

Each type of debt financing option comes with a good amount of flexibility. You need to make periodic payments for the interest, and the principal amount can be paid once the tenure comes to an end. You get enough clarity about the repayment schedule at the time of borrowing, so you can manage your finances accordingly.

Diversification of Funding Sources

Usually, it is not recommended for businesses to rely on a single avenue for their funding requirements. You can opt for debt financing along with other options such as invoice financing, equity, internal funds, etc. This leads to diversification of funding sources and minimises the risk.

While there are no known disadvantages of debt financing, it is crucial to make a careful decision. There are several different types of debt financing, and each one caters to different requirements of business owners. You need to take several factors into consideration and make a choice accordingly.

 At Muthoot Finance, we offer a wide range of financing options for businesses, such as a startup loan, an MSME loan, a working capital loan, etc. You can explore all the options and take your pick. For more information, you can visit your nearest Muthoot Finance branch.