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All about debt financing

bills39158685.jpgDebt financing is one of the ways you can take on money to help your small business. One of the benefits of debt financing is that is allows those people who do not want to take on investors, to maintain total control of the business. In addition, many people want to pursue debt financing in order to start up your business, and find that this is generally the easier route. However, it is vitally important to clearly understand what debt financing is, its advantages and the perils of using it.

There are many different kinds of debt financing. Most potential small business owners try to tap their own sources of funds first, by using personal loans, home equity loans, and even credit cards. Sometimes, family or friends may be willing to loan you the necessary funds at lower interest rates, and better repayment terms. Applying for a business loan is another option. There are both advantages and disadvantages of debt financing. Knowing and understanding them before you make a decision, is crucial to making the right choice. Here are some of the advantages of debt financing-

  • Debt financing allows you to have control, regarding your business. If you choose debt financing, you do not have investors or partners to answer to, and you can make all the decisions. Best of all, you own all the profit you make.

  • If you choose to finance your small business, using debt, the interest you repay on your loan is tax-deductible. This also means that it shields part of your business income from taxes and lowers your tax liability every year. Keep in mind that your interest is usually based on the prime interest rate.

  • The lender(s) from whom you borrow money do not share in your profits. All your lender does, is say yes or no, to your loan.All you have to do is make your loan payments in a timely manner.

  • If you choose to use debt financing, you can apply for a Small Business Administration loan that has more favorable terms, for small businesses than traditional commercial bank loans.

  • It should be noted, however, that there are significant disadvantages connected to using debt financing. These disadvantages are not to be taking lightly, and can put quite a burden on a small business. Some of these disadvantages are-

  • You may have large loan payments at precisely the time you need funds for start-up costs. In addition, it is crucial to understand that if you don't make loan payments on time to credit cards or commercial banks, you can ruin your credit rating, and make borrowing in the future difficult or impossible. If you don't make your loan payments on time to family and friends, you can strain those relationships.

  • You may need to put up significant personal assets. For a new business, commercial banks can require you to pledge your personal assets, before they will give you a loan. Anyone considering this needs to understand that if your business goes under, you will lose your personal assets. This can happen even if you have put up your personal residence as collateral. Some financial advisors will tell you that if you incorporate your business, your personal assets are safe. You should not count on this. It is crucial to understand that even if you incorporate, most financial institutions will still require a new business to pledge business or personal assets as collateral for your business loans. You can still lose your personal assets.

  • Any time you use debt financing, you are running the risk of bankruptcy. The more debt financing you are using for your small business, the higher the risk of bankruptcy.

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