Sometimes in business, finances are tough. You might find yourself in a position where you need to sell assets or apply for a loan to help finance some of your business operations. One way to raise funds is through debt financing.
Debt financing or financial leveraging happens when a company raises money for its working capital by selling debt instruments. These instruments are sold to individuals or investors in return for lending money to the company.
Small businesses might not think of debt financing as an option, but it is possible. You just need to know how to do it properly so that your business remains in operation, and you gain working capital.
In this article, we look at what debt financing is and how you can do it for your business.
What Is Debt Financing for Small Businesses?
For small businesses, debt financing can help you go after opportunities quickly. You can increase your inventory, upgrade inventory and better your cash flow. You will know when your business needs financial leveraging when there aren’t enough capital reserves, or when you want to use external funds to accelerate growth without letting go of ownership.
Before you decide to explore debt financing as an option for your business, you need to know the different types of debt financing.
Types of Debt Financing
Here are the types of solutions that you can leverage as a small business.
Traditional Bank Loans: You can get a business loan from any bank in South Africa. The loan can help you with your working capital needs. Before you apply, ensure that you can repay your loan and meet all the requirements.
Government Relief Scheme: There are a number of government funding initiatives which can help you with debt financing. You can find government funding opportunities in our guide.
Business Credit Cards: Business credit cards are considered a revolving line of credit. You can use the credit card for anything your business needs. The best thing about business credit cards is that you only need to pay back what you have spent.
Asset Finance: You can get asset financing from the Small Enterprise Finance Agency (SEFA). Asset financing can help you purchase any new or used moveable assets for your business.
Merchant Cash Advance: Merchant cash advances can help you with debt financing. This is a great option for small businesses because the repayments are affordable, and approval is quick.
These are the best debt financing options for small businesses. The repayment terms and rates are not too expensive and for some of them, you can use the loan for anything as well.
Fast & Flexible Business Financing
Advantages and Disadvantages
Much like any other form of funding/financing, there are good and bad sides to debt financing.
Pros of Debt Financing
The first advantage of debt financing is that it allows you as a small business to leverage a small amount of money into a bigger sum. This allows you to grow your business much quicker than you planned. Debt financing is also tax deductible in South Africa, but only under certain conditions, like if the debt is incurred to generate an income eg a business loan.
Another advantage of debt financing is that it allows you to keep control of your business. This is the opposite of equity financing which is when you get funding in exchange for a share of your business.
Disadvantages
One of the disadvantages of debt financing is the fact that the money you pay back will be bigger than the amount you borrowed. This is a downfall because you have to repay the loan no matter how good or bad your business revenue is.
Another pitfall is that if you can’t pay back the loan, your business will appear as a huge risk to potential investors and other lenders. This could also lead to higher borrowing costs for your business in the future.
Lastly, in debt financing, some lenders may put strict conditions which restrict you from additional borrowing. This forces you to finish paying off your current loan before you can apply for additional financing. Lenders do this as a way to minimise risk and ensure you can pay your loan back.
Now that you know the advantages and disadvantages of debt financing, you can see if it’s the perfect financing solution.
Don’t wait until you are in trouble before you apply for debt financing. Find the right lender for you and get the financing you need to grow your business.
For actionable business mentorship, visit SME Advice and book an appointment with one of our experts.
