Debt
Debt can be a loan, line of credit, bond, or even an IOU -- any promise to repay borrowed amounts over a certain time with a specified interest rate and other terms. Debt is accounted for as a liability of the company, and interest payments are deductible business expenses. In the event of bankruptcy or insolvency, debt holders take priority over equity holders.
For a small business, debt financing has both advantages and disadvantages. On the plus side, debt can be relatively simple to secure through a bank or other financial institution and is available with a broad range of terms, allowing you to customize the debt to meet your specific needs. Whether you are seeking a three-month bridge loan or a long-term commitment, you can usually find an institution that's willing to work with you. And since most debt entails regularly scheduled payments of interest and often principal as well, debt is easy to plan around. Perhaps most important, debt, unlike equity, will not dilute your ownership interest in your company.
On the minus side, however, financing with debt can be more expensive, and you will have to meet scheduled interest and principal payments regardless of your cash flow. Although loan terms can be negotiated to build in flexibility, ultimately the money must be paid back.
Debt is most often used to fund a specific project or initiative that has an identifiable implementation time frame. It's also used as a cash flow backup in the form of a revolving line of credit. To attract lenders, you will need to have a good personal and business credit history, sufficient cash flow to repay the loan, and/or sufficient collateral to offer as a second source of loan repayment. In smaller businesses, personal guarantees are likely to be required on most debt instruments. You should also not be carrying significant debt already.
- 1• Small-Business Financing: Debt vs. Equity
- 2• Debt
- 3• Equity
- 4• Striking a Balance
Personal Finance