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Enterprise Center Tips For Debt Financing
"You have to spend money to make money." - Plautus
Plautus was a Roman playwright and comedian who was born in 254 BCE. Over 2,200 years have passed, yet this statement still holds truth today.
But, how do you spend money when you don’t have money? One potential answer: debt financing.
Debt Financing
Debt financing is the act of borrowing money from lenders or banks and can be a great tool to help early-phased ventures grow.
If you need capital, various lenders or banks provide debt financing as a means to sustain your venture short-term. You as the "borrower" borrow money and owe the amount borrowed plus interest back to the "lender." Lenders set loan amounts, interest rates, and payment schedules based on a number of factors including the borrower's business credit.
Here are a few advantages of debt financing:
- The lender has no control over or ownership in your business (unlike an investor, who receives a portion of your business in exchange for their investment)
- The interest paid is tax-deductible
- Loan payments do not fluctuate
- You create and build business credit
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You may be a good candidate for funders like Kiva or your local CDFIs (community development financial institutes), which are designed to provide small loan amounts to early stage small businesses at low to no interest rates.
Be prepared
Debt is an expense you have to pay regularly—typically starting right away—and can affect your bottom-line. Unpredictable events (internal or external to your business) that cause delays in payment can affect your credit, future ability to borrow, founder stress level, and more. Make sure you’re prepared to pay back the loan and fully understand the repayment schedule terms before taking one out!
There are two types of debt financing: venture debt and convertible note.
Venture debt
- Loans offered by banks or other lenders
- Sometimes this can look like a loan against intellectual property or assets of the company
- Sometimes this can look like a loan working against capital requirements
- Does not involve equity at any point
Convertible note
- Short-term debt that converts to equity later when the venture raises funds
- Designed to benefit those investors willing to take the risk of investing early
- Allows investors to convert the amount of their loan, plus accrued interest, into equity at a reduced price relative to the investors in a subsequent funding round.
The U.S. Small Business Administration (SBA) works with select banks to offer a guaranteed loan program that makes it easier for small businesses to secure funding.
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