A firm (business or professional practice) often needs funds to continue with its business operations or bridge a small gap in its working capital. At such times, the business uses one or the other methods to raise funds. Debt financing is one of the most common methods of financing a business. It is quick, easy and has the least hassles. In this article, we shall understand what debt financing is, followed by how it works and the pros and cons of the same.
Debt financing is the process of borrowing money from a source (often a bank or a Non-Banking Finance Company – NBFC or even the general public) with the commitment to pay it back with interest, within the specified tenure at the pre-decided rate of interest.
While we generally think of only banks and NBFCs as the source of debt financing, companies raise funds from the general public as well. This is done through the issuance of bonds, commercial papers, debentures, etc.
Debt financing involves the raising of funds from a lender and paying back in EMIs. Hence, it is a prudent practice to check certain things related to your business before you decide on debt financing. You need to check the duration for which you need the funds, the cash flows generated from these funds, etc.
For the borrower, debt financing works just like a regular debt. The borrower (a company in this case) applies for the loan either from a bank, NBFC or the general public. The terms of the loan are fixed. These include:
There are different variations in which debt financing can be classified. Some of the common ways of debt financing are mentioned below:
Debt financing is a great way for a business to leverage a small amount and generate a large amount by investing the same in business operations. Hence, debt financing can be good or bad, depending on how the debt is used, treated and serviced.
As you can see, the advantages of debt financing far outweigh the disadvantages. Hence, it makes sense to avail of debt from a good lender, so that you can take your business to greater heights. If you need a good source of debt financing for your business, you can avail of a Business Loan from Poonawalla Fincorp. We have an extremely hassle-free application process, easy eligibility criteria, attractive interest rates, flexible repayment tenure and best-in-class customer service.
Term loans, bond issuance, debentures, commercial paper and credit lines are some examples of debt financing.
In the case of debt financing, the borrower borrows an amount from the lender at a pre-determined rate of interest and repayment tenure. Rate of interest and tenure can change over the period of the loan. Also, the lender(s) can be Banks, NBFCs, individuals or a consortium. The loan is repaid in the form of EMIs over its tenure.
Debt financing does not result in dilution of stake for the promoter(s), while equity financing almost always results in stake dilution. Debt is repaid over a certain tenure while equity remains “unpaid” till the time the issuer buys back the equity. Also, debt has a much lower cost compared to equity.
There are many types of debt financing, as mentioned above.
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