Debt Financing - Short Term and Long Term,Equity financing - Advantages and Disadvantages
Debt financing is when a business chooses to go into debt in order to get the money needed to continue operating the company. The debt is acquired through the acceptance of a loan wherein the business owner agrees to pay back the money gradually and with interest.
Short Term Debt Financing
Debt financing can be classified under one of two categories: short term and long term. Short-term debt financing usually means that the lender and borrower agree that the full borrowed sum, plus interest, will be paid back in full within 1 year.
Long-Term Debt Financing
Long-term debt financing is still a loan taken from a bank or financial institution with a promise of repayment, plus interest. Instead of being used for the daily operation of a business, long-term debt financing is generally used for acquiring a building, a plot of land or any expensive equipment or machinery needed to operate or expand the business. Long-term debt financing is paid off over a period longer than a year.
There are a couple of advantages associated with debt financing.
1.It is one of the only ways to get fast money for your business without giving up any ownership.
2.When you choose debt financing you retain full ownership privileges over your business and the lender has no legal say in how you run it.
3.The other main advantage is that debt financing loans are tax deductible. By considering the loan a business expense you can eliminate your payments and interest from the business's income tax.
While taking out a loan to run your business is not considered irresponsible, continual debt may be unattractive to potential investors. Also, in the event of your business failing, you would still personally be held responsible for repayment of the loan, which could result in the loss of any collateral, should you not be able to pay. Every loan you take out goes on your credit rating and continual loans could negatively affect your credit score, raising interest rates and making future loans harder to get.
A common alternative to debt financing is equity financing, when a lender gives you money in exchange for partial ownership of the company. While this method leaves you with no debt to repay in the traditional sense, it means you'll have to sell off part of your company and will no longer be the sole owner. In this scenario the lender becomes an investor and is paid back through company profits but continues to own part of the business after the debt is repaid.