How to Borrow Money, Part 2: Debt Financing

Debt Financing

Debt financing means borrowing money that must be paid back over a period of time, usually with interest. It can be a short-term: less than a year and a long-term more that a year. You do not relinquish any ownership rights by taking a loan and limited by obligation of paying a loan back with interest. This is why loan for new businesses usually secured by one or more of the following: owners’ personal guarantee, real estate, company assets, etc.

The disadvantage comparing to the equity financing is that you must make scheduled payments regardless of your company’s financial situation.

Debt sources can be divided into two groups: non-professional such us relatives, friends, and employees, etc. and professional such as banks, credit unions, etc. Financial Institutions, by themselves, traditionally provide short term financing for small and mid size businesses: line of credit, equipment loan, etc. Long term loans in many cases guaranteed by the Small Business Administration loan program that helps leverage out risk for financial institutions.

There are some pros and cons in both Equity and Debt Financing. The best capital structure will depend on many different factors. For more sophisticated cases I suggest to hire a seasoned Financial Consultant.

Points the borrower usually evaluates before you giving the money:

1. How good is your credit history
2. Do you a solid collateral
3. Will you be able to repay the loan
4. Does your management team have enough management experience

Your personal financial situation while starting a business

It is always a good idea to build your personal credit history. In the beginning your business does not have any credit history and lender will use your personal data to evaluate a loan terms. Order you personal report to see where you stand and check it for any unexpected errors.

Work with your personal budget. You need to understand that usually you will not be able to take any cash from new business for a while. Make sure that you have enough money to start you business venture and enough money to pay you bills until business will become cash producing.

Put together projections and classify your future business expenses. Some of the expenses will be one-time costs such as the fee for incorporating your business; some will be ongoing such as inventory, insurance, etc.

There are two types of expenses: variable such as inventory, sales commission, etc. and fixed such as rent, utilities, etc. If you feel that you do not have enough expertise to do budgeting and forecasting it might be a good idea to hire a professional to do that.