What Is Debt Financing and Should You Use It?

If there’s one word small business owners dislike hearing, it’s “debt.” Just the mention of debts is enough to send shivers down your spine. You know how hard you work to make healthy profits, so the idea of having extra weight to deal with is understandably uncomfortable. That said, debt financing isn’t as scary as you may think. You just need to learn more about it.

What Is Debt Financing?

It may shock you to know that debt financing includes things such as small business loans (SBA 7a and 504 loans), real estate mortgages, working capital loans and many other traditional bank loans. Even though the name sounds bad, it really only means that you’re borrowing money from a lender. You have to make payments on the loan principal, which is technically a form of debt.

The reason you hear this term tossed around is to help distinguish term loans from equity financing. When you choose an equity loan, you don’t have to pay back the money. Instead, investors receive an ownership stake in your business, essentially making them secondary partners. They receive a portion of your profits every month.

What Are the Pros and Cons of Debt Financing?

Taking on financial obligations can seem counterintuitive as a business owner, but it actually may be one of the smartest decisions you make. As the saying goes, you need money to make money. Investing in business growth may be essential to keeping your company financially healthy.

For example, imagine that you run a construction business. Should you take out a loan to purchase equipment? On one hand, this means taking on debt via a loan. But if your competitors have equipment and offer services you can’t, investing in new equipment may be the only way to compete. Without it, your business simply can’t generate enough revenue. In this situation, a loan is a smart move.

Before signing on the dotted line, though, you need to make sure you can afford the payments. Good planning is how you get around the downsides of loan debts. Don’t take on more debt than your business can comfortably handle while maintaining normal business operations.

What Other Options Do You Have?

There is another class of financing you can look into. Alternative financing may provide funding options that don’t involve equity or debt. You can get a cash advance or turn unpaid invoices directly into capital. These programs aren’t right for every business, but they have specific benefits for many companies.