Debt Financing

 

Debt financing is basically money that you borrow to run your business. It is divided into two categories, based on the type of loan you are seeking: long term debt financing and short term debt financing.

 

Long Term Debt Financing applies to assets your business is purchasing, such as equipment, buildings, land, or machinery. With long term debt financing, the scheduled repayment of the loan and the estimated useful life of the assets extends over more than one year.

 

Short Term Debt Financing applies to money needed for the
day-to-day operations of the business, such as purchasing inventory,
supplies, or paying the wages of employees. Short term financing is referred to as an operating loan or short term loan because scheduled repayment takes place in less than one year.

 

Debt financing is attractive because you do not have to sacrifice any ownership interests in your business, interest on the loan is deductible, and the financing cost is a relatively fixed expense.

 

Selecting a bank or conventional lender

Banks include traditional savings banks, savings and loans, and commercial banks, and are generally the first place small business owners think of when looking for institutional financing.

 

Credit unions can offer generous terms to their members, but make mostly consumer loans.

 

Consumer finance companies may be willing to make higher-interest loans to higher-risk borrowers.

 

Commercial finance companies may be worth considering if you need a loan for inventory or equipment purchases.

 

Types of bank loans

Working capital lines of credit for the ongoing cash needs of the business

 

Credit cards: higher-interest, unsecured revolving credit

 

Short-term commercial loans for one to three years

 

Longer-term commercial loans: generally secured by real estate or other major assets

 

Equipment leasing for assets you don't want to buy outright

 

Letters of credit for businesses engaged in international trade

 

 

Direct and indirect costs
The final cost of borrowing money often involves much more than just the interest rate. A variety of other monetary and nonmonetary costs should be considered in determining the real cost of borrowing.

 

Consider: 1) direct financial costs, such as interest rates, points, penalties, and required account balances, 2) indirect costs and loan conditions, such as periodic financial reporting, maintenance of certain financial covenants, and 3) subordination agreements personal guarantees needed to obtain the loan.

 

What banks look for
1)credit history of the borrower
2)cash flow history and projections for the business
3)collateral that is available to secure the loan
4)character of the borrower
5)loan documentation that includes business and personal financial statements, income tax returns, and frequently a business plan.

 

Asset-based financing
To generate working capital or to meet specific short-term cash needs, small businesses may use certain short-term assets as collateral for commercial loans. Common types of asset-based financing are:

1) Accounts receivable financing uses the receivables as collateral. As the business collects the receivables, the proceeds are used to repay the loan or line of credit.
2) Inventory financing is a similar type of loan, using inventory as collateral.
3) Factoring is a process whereby accounts receivable are actually sold to a third party (the factor) for a discount price, after which the factor takes on the job of collections.

 

Leasing
Leasing assets, rather than purchasing them, is a form of financing because it avoids the large downpayment frequently required for asset purchases and it frees up funds for other business expenditures. However, you should be aware that leasing from conventional lenders may be difficult for startup businesses because traditional lenders require an operating history from prospective lessees.

 

Trade credit
Suppliers can often provide an easily available way to supplement conventional borrowing. Startup businesses may benefit from shopping for prospective suppliers as soon as the entrepreneur has a business location picked out

 

Life insurance companies
Your existing policy can be a source for low-interest policy loans.