What is debt financing? What are your options?

Debt financing, also known as debt funding, is when businesses borrow money from a third-party creditor, like a bank or other financial institution. Debtors promise to repay the amount in full at a later date and will typically owe creditors interest payments on borrowed funds. Fees are also common.

Debt financing is different from equity financing, such as the issuance of stock , because companies retain full ownership but take on the obligation to repay lenders regardless of business performance.

Debt financing encompasses a range of options tailored to suit the diverse needs of businesses. These include:

Traditional term bank loans

Traditional business loans from banks are a common form of debt financing. They involve borrowing a fixed amount from a bank and repaying it over a specified period, typically with interest.

Lines of credit

A line of credit is a pre-approved credit facility that lets borrowers access funds up to a certain limit. It functions like a revolving credit account, where the borrower can borrow, repay and borrow again as needed, within the approved limit.

Asset-based financing

Asset-based lending involves using a company's assets , such as accounts receivable, inventory or equipment, as collateral to secure a loan. The loan amount is typically a percentage of the value of the pledged assets.

Invoice financing

Technically a form of asset-based financing, invoice financing allows businesses to receive early payment on their outstanding invoices. The financing company advances a percentage of the borrowing company’s invoice value. When the invoice is paid, the remaining amount (minus fees) is released.

Hire purchase

Again, this is a specific type of asset-based financing whereby an amount is borrowed to fund the purchase of a specific asset. The borrowing is effectively secured against the asset itself. There is often a deposit, a period of regular repayments and then a final, larger balloon payment with this type of funding.

Commercial mortgages

A commercial mortgage is a mortgage loan secured by commercial property , such as an office building, shopping centre, industrial warehouse or apartment complex. The proceeds from a commercial mortgage are typically used to acquire, refinance or redevelop commercial property or can help to bolster working capital in certain circumstances.

Business credit cards

It's important for businesses to use business credit cards judiciously and manage their finances responsibly. Paying off the balance in full each month helps avoid accumulating high-interest debt and maximises the benefits of using a business credit card as a debt finance option.

By comprehending the features and benefits of each option, business owners can identify the most suitable debt financing instrument for their growth strategies.

Creditworthiness and eligibility

Lenders evaluate a business's creditworthiness when considering debt financing applications. Many factors play a role in determining your eligibility, including:

• Credit history
• Revenue streams
  
• Profitability
• Collateral
• Personal guarantees

Additionally, maintaining and presenting a strong business plan that highlights growth strategies, market analysis, financial projections and repayment plans is vital. These elements collectively enhance creditworthiness and increase the chances of securing debt financing.

The chances of successfully securing a new debt facility are greatly increased by ensuring that lenders have access to high-quality management information. Lenders will want to understand previous performance and future potential.

It is essential that you present this information in a format that speaks to the lender’s requirements. Leaving the lender to look for the information they need greatly reduces the chances of a successful application. There may also be covenants associated with any borrowing which require regular reporting to the lender. At Rickard Luckin, we are experienced and respected in presenting such information to lenders.

What are the risks, benefits and key considerations?

Debt financing offers numerous advantages for businesses, including immediate access to capital while retaining ownership and control.

However, it is crucial to evaluate associated risks. These may include:

• Potential cash flow constraints
• Default risk
• Credit score implications

By conducting a thorough risk analysis, diversifying funding sources and maintaining open lines of communication with lenders, businesses can mitigate risks and optimise the benefits of debt financing.

Businesses pursuing debt financing should carefully consider several factors, including interest rates, repayment terms, collateral requirements, and potential financial covenants imposed by lenders. Understanding the implications of these factors ensures that businesses align their financing decisions with their growth objectives.

Government support and funding programs

The Government offers various support initiatives and funding programs that can augment debt financing options for businesses. These programs often provide access to more favourable terms, including lower interest rates and extended repayment periods.

By taking advantage of government support, businesses can bolster their growth ambitions while alleviating some of the financial burdens associated with debt financing.

Get in touch

Debt financing can be a catalyst for businesses looking to achieve rapid growth and expansion. However, it may not be a suitable option for your business. If you would like to discuss your circumstances further, please get in touch.