Debt financing is the process of borrowing money from an outside source to continue operating a business. After taking out a business loan, a business owner must pay back the principal amount plus interest. In this article, we examine the advantages and disadvantages of debt financing.
Advantages of Debt Financing
Debt financing has several advantages, including:
No loss of ownership: Business owners don’t have to give up ownership with debt financing. When a business owner takes out a business loan, he or she is simply required to make the payments on time for the life of the loan. However, other forms of financing, such as an initial public offering, require owners to give up equity in the form of stock.
Tax deductions: Another advantage of debt financing is tax deductions. A business loan is classified as a business expense. Therefore, the principal and interest payment on the debt may be deducted from a business’s income taxes.
Establishment of business credit: Debt financing also allows business owners to establish business credit. Excellent business credit is imperative for businesses seeking low-cost, long-term debt funding. Therefore, the ability to build business credit is a major advantage to debt financing.
Debt can create growth: Finally, debt, when used wisely, can help companies grow. Common uses of long-term debt include hiring new workers, buying inventory or equipment, and increasing marketing.
Disadvantages of Debt Financing
Despite its many advantages, debt financing isn’t without its drawbacks. Disadvantages of debt financing include:
Repayment: Although this may sound obvious, business loans must be paid back—no matter what. Therefore, even if a business goes under, the business owner is obligated to continuing making payments on the loan. If a business owner guarantees a loan, the failure to pay may put his or her personal assets at risk.
Credit impact: Each business loan that a business owner takes out will be noted on his or her credit rating. Taking out too many loans can cause a business owner’s credit scores to drop.
Collateral requirement: Finally, most lenders require some form of collateral before making a business loan. Collateral is an additional form of security that provides a debtor with a second source of loan repayment. Generally, if an asset can be sold by the bank for cash, it’s considered collateral. Thus, if a business owner fails to abide by the terms of a business loan, the collateral that he or she put up to obtain the loan may be liquidated by the bank.
Contact Our Business Transactions Attorney
As a business owner, you put a lot on the line. At Business Law Firm, LLC, we understand the risks associated with growing your business, and our primary goal is to help you minimize these risks. When you come to us for help, our experienced New York City and Long Island business transactions attorney will work to help you avoid the types of legal issues that can disrupt your business and affect your bottom line. Please contact us today to schedule a preliminary consultation.