When you think about how businesses get capital to fund their operations, most people probably think about equity financing. After all, the term “capital” refers to money you invest to get a return on it someday. For example, if you buy stock from a company, you own a small piece of that company and will hopefully see your investment grow over time.
However, many companies also use debt financing as an alternative way to raise capital when they cannot or do not want to give up ownership of their business in exchange for capital. Here’s a closer look at when a company might use debt financing and how debt differs from equity as a source of capital for businesses.
When Do Companies Use Debt Financing?
Debt financing is a type of financing in which a company receives the money in the form of a loan that it must repay with interest over time. Debt financing is often used to fund capital expenditures and make large purchases, such as buying a piece of equipment or building a new facility.
It can also be used to repay an existing loan, such as when a company pays off a loan to get out of debt faster. Businesses may choose to use debt financing over equity financing because they do not want to give up a portion of their company to investors or they do not have the cash flow to fund their operations through equity. For debt financing, you can contact Joseph Stone Capital.
The Pros of Using Debt Financing
The most obvious benefit of using debt financing is that a business gets the money it needs to expand its operations or make investments sooner. The company may also get a lower interest rate than it would on an equity financing round. Additionally, the company may be able to deduct the interest paid on the loan from its taxes. Debt financing can also be a good option for companies that do not have a lot of cash flow or equity to offer as collateral. This is especially true if a company wants to borrow money from a government-backed lending source to avoid a higher interest rate. On the other hand, Joseph Stone Capital does help with debt financing.
The Cons of Using Debt Financing
There are some downsides to using debt financing.
- Debt comes with interest, so the company must pay back the money plus interest.
- Lenders can force a company to pay back the loan even if that company goes through bankruptcy.
- If the company fails to pay back the loan, the lender can take actions such as taking the company’s assets or garnishing its employees’ wages.
- Much of the public sees a company’s debt as a negative—not only in the amount but also in the fact that the company chose to take on the debt at all.
Key Takeaway
Debt financing is a type of financing in which a company receives money in the form of a loan that it must pay back with interest over time. Debt financing is one-way companies raise capital, but it comes with several downsides, like the need to pay back the loan with interest and possible loss of assets if the company fails to repay.