Author
David HillChief Operating Officer
0403 037 664
Running your own business might seem like a dream come true, however, there’s no doubt it comes with major challenges. Finding customers, managing staff, ensuring compliance, dealing with competition, managing risk and much more – you’re dealing with demands small to large every day.
Failure is common, especially for new businesses, so what can you do to give your business exactly what it needs to grow and succeed? Debt financing could drive your business forward and give it the edge it needs to stay out of trouble.
What is debt financing?
Debt financing occurs when a business borrows money to support its operations, with a commitment to repay the loan plus interest within a set time frame.
Unlike equity financing, you’re not raising money by attracting investors who then have a stake (and claim over profits) in the business. You maintain ownership and control over your business.
How debt financing works
You can use debt financing for any aspect of your business, whether it’s working capital or to make an acquisition. Your repayments could be monthly, half-yearly, or towards the end of the loan term, depending on your agreement.
Debt finance can be secured or unsecured against an underlying business asset. Examples of debt finance include:
- Bank loans
- Overdrafts
- Mortgages
- Credit cards
- Equipment leasing or hire purchase
Note that with a business, debt financing interest, fees, and charges can be claimed against your business income.
Long-term and short-term financing
Debt financing can be short-term or long-term. If you’re buying things like machinery, buildings, and equipment, the loan time frame could be longer than a year (and the asset used as security for the loan). Long-term debt finance can also be appropriate if you’re employing more staff.
In contrast, short-term debt financing – such as a line of credit or credit cards – might be used for daily operations like supplies, inventory, and wages. With this type of loan, you might have an agreement to repay within a year.
As with any type of debt, an element of risk is involved so it’s important to consider how much debt you can sensibly take on and review your debt-to-equity ratio.
The benefits of debt financing
Debt financing is among the most popular forms of financing. So, what makes it so widely used?
- Ownership and control – Unlike equity financing, debt financing allows you to retain complete control over your business. You don’t have to answer to investors, therefore there’s less potential for disagreements and conflict. Even if it’s a secured loan, you would give up only on the collateral (and not your business) if you were to default.
- Tax deductible – Debt financing comes with tax benefits, helping you reduce your tax bill. Since debt financing is a business loan and not a private, personal loan, you can claim a tax deduction on fees, charges, and interest.
- Profit sharing – With debt financing, your key obligation is to make the agreed payments on time. This is in contrast to equity financing, where you have to share your business profits with the equity investors.
- Accessibility – Get the capital you need to grow your business through a relatively straightforward process. When compared to equity financing, debt financing tends to be less complicated because there’s less compliance and you don’t have to go through the process of screening equity partners or the convoluted process of negotiating and coming to an ownership agreement.
- Credit history – You can use debt financing to establish a proven credit history to help your business secure other types of financing in the future.
- Planning and predictability – You’ll know exactly how much you need to repay, which helps with budgeting and planning.
- Flexibility – You can secure short-term, medium-term, or long-term loans for an amount appropriate for your business’s needs.
Types of Business Finance
Businesses generally access funds through two main sources:
- Debt Finance: Borrowing money from banks or non-traditional lenders, repaid with interest.
- Equity Finance: Raising funds from investors in exchange for ownership stakes.
Many businesses use a mix of both, alongside other sources like government grants, private funding, and business contests.
Borrowing from Non-Bank Lenders
Also known as alternative lenders, these providers offer more flexible terms than traditional banks. However, their conditions vary widely - always review carefully and seek financial advice if unsure.
Debt Finance Options
Retail & Supplier Finance
- Retail finance: Store credit to purchase goods, often with high interest rates or limited no-interest offers.
- Supplier credit: Pay suppliers later, allowing you to use funds elsewhere (may involve fees).
Invoice Factoring & Finance
- Factoring: Sell unpaid invoices for immediate cash (typically 80–90% upfront).
- Invoice finance: Borrow against invoices, then repay once your customers pay.
Business Line of Credit
A flexible facility from a lender, allowing you to borrow up to a set limit based on your business history or assets.
Unsecured Business Loan
Loans without collateral, typically based on your cash flow, revenue history, or personal guarantee.
Peer-to-Peer Lending
Borrow directly from individuals or businesses via online platforms. Can be debt or equity-based, depending on the terms.
Commercial Mortgage
Secure funding by mortgaging business property—potentially with better rates due to lower risk for the lender.
Equity Finance Options
- Venture capital: Professional investors or funds invest large sums in return for equity and high growth potential. They often take an active role in the business.
- Incubators: Offer funding and mentoring to startups in exchange for a small ownership share. Suitable for early-stage companies.
- Family & friends: Accessible and flexible, but formal agreements are essential to avoid misunderstandings. This can also be structured as a loan.
- Crowdfunding: Raise funds from a large number of contributors online. Can be equity-based (ownership) or reward/debt-based (interest or product delivery).
- Angel investors: Private individuals who invest in exchange for equity. They often want significant ownership and may provide strategic advice.
- Going public: Listing your company on the stock exchange can raise substantial funds and boost visibility, but it’s complex and market-dependent.
Debt versus equity; which to choose?
While both debt and equity could help your business grow, it’s useful to consider the different implications they could have for your business.
- Taking on debt means you’ll need to pay back the money with interest, while equity means you’ll be sharing ownership and control.
- Debt won’t dilute your ownership interest and you won’t need to share future business profits.
- As interest payments are more or less known in advance, you can easily plan your repayments.
- Debt is repaid at some point so unlike equity, it doesn’t include a permanent change to your business (ownership).
Understand the risks
It’s important to understand the differences between good and bad debt.
Even though equity financing means an injection of funds without loan repayment obligations, equity is considered a high-risk investment - whilst debt is considered low risk.
At the same time, however, having a high debt-to-equity ratio could constrain your business growth because you’re paying a lot to service your debt.
Another issue to consider is that debt finance is technically a loan or liability of your business. On the other hand, equity finance is technically an asset of the company, as the injection is considered the business’s own funds.
Exploring your business’s finance options
When weighing up your finance options, consider things like debt-equity ratio, ownership, control, repayments, and your business’s individual needs. If you’re using both types of financing, striking a balance between the two could optimise cash flow and ensure you’re getting an appropriate share of the profits.
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