Debt finance is borrowed money that you pay back with interest within an agreed time frame. The most common forms of debt finance include bank loans, overdrafts, mortgages, credit cards and equipment leasing/hire purchase.
Advantages of debt financing
- Maintaining ownership - unlike equity financing, debt financing gives you complete control over your business. As the business owner, you do not have to answer to investors.
- Tax deductions - unlike private loans, interest fees and charges on a business loan are tax deductible. This is a big incentive for debt financing. Learn more about tax deductions for your business.
- Retaining profits - your only obligation to your lender is making repayments within agreed time frames. You do not have to share your business profits.
Disadvantages of debt financing
- Accessibility - banks are conservative when lending money. New businesses may find it difficult to secure debt finance.
- Repayments - you need to be sure your business can generate enough cash to service the debt (i.e. repayments plus interest). Remember, if your business fails you are still obliged to repay your debts.
- Credit rating - failing to make repayments on time will affect your credit rating, which may affect your chances of securing future loans.
- Cash flow - committing to regular repayments can affect your cash flow. Start-up businesses often experience cash flow shortages that make regular payments difficult.
- Bankruptcy - unless you have a guaranteed way of paying back your loan, any business that uses debt financing is risking potential bankruptcy. This is particularly serious if you have pledged your personal assets to secure a loan.