What is the significance of debt financing?
Debt financing can be both secured and unsecured, with or without collateral. Although credit of any form – debts or loans – has been seen unfavourably for decades, It can serve as a critical turning point in a company’s growth and progress. Debt financing may have a negative connotation, yet healthy quantities of debt to support a company’s growth are always vital.
Here are the top five advantages that businesses receive when they accept debt funding when it is required.
1. Keep ownership
Raising debt is a terrific option to providing investors your company’s shares in exchange for funding.
Raising debt is a more cost-effective technique of raising cash for business expansion than unorganised kinds of debt or equity.
All corporate finance professionals agree that the cost of equity is always higher than the cost of debt, and businesses must recognise this as well. As a result, they can take advantage of cheap interest rates and borrow money to help their firm grow.
3. Several options
Enterprises have several options for debt mobilisation; there are numerous lenders (for example, banks, NBFCs, and small finance institutions, among others) and debt products to meet their needs (Eg: short term loans, long term projects loans etc.)
4. Financial self-control
Raising debt also encourages financial discipline and responsibility in businesses. It encouraged the judicious use of the cash raised, as well as the responsibility of working toward larger goals to repay the debt.
Difficulties encountered with raising debt
Though generating debt appears to be a terrific way to obtain finances at a low cost, it is not as simple as one may think. Despite having killer products or services, fantastic financial numbers in the past, a decent credit score, and/or a highly convincing business plan, businesses are sometimes rejected.
Here are some of the most common obstacles that businesses may face when raising debt:
Lack of clarity
Many businesses lack a business plan when they seek to raise loans. The disadvantage of this is not knowing how much money is required for business expansion, paying vendors, stockpiling raw supplies, and so on. Many people believe that taking on as much debt as possible is the best way to go; nevertheless, this can be harmful. Uncertainty over why and how much debt an organisation has to raise can stifle growth.
Choosing the Right Product
If the wrong type of debt is chosen, it might become a liability rather than a source of relief for the business. Many businesses may end up incurring the wrong kind of debt, jeopardising their future chances. For example, any loan raised that has the potential to reduce the net value of your business rather than increase value is the improper form of debt. Instead of increasing debt just for the sake of low interest rates, this is a bad type of debt that you can avoid.
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Capability to assist with evaluation
Numerous businesses are unaware of the regulatory compliances placed in place to protect their interests. Failure to be aware of legislation and associated compliance guidelines while raising financing might trap businesses in scenarios that may not end well.
Choosing the Right Partners
When considering raising debt, businesses can choose from a variety of loan partners. One of the most common methods is to ask friends and family for money. Bringing in family and friends, on the other hand, comes with significant hazards. You are not only jeopardising their financial future, but you may also strain your connection with them if things do not go as planned.
Choosing the proper partner can have a huge impact on how the organisation generates financing, what the turnaround time for disbursement is, and how successfully they access a variety of possibilities.
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Tips on raising debt efficiently by businesses
Now that you understand the types of problems that businesses may face while getting loan, here is a checklist you can use to raise debt efficiently:
Have a business plan that is scalable
This is done in the planning stage when you intend to raise debt. The business plan defines how your company intends to fulfil its short-, long-, and mid-term objectives. A business plan will assist your company and investors in planning for organic/inorganic growth, mergers and acquisitions, and outlining the financial requirements to accomplish so.
This will assist both the firm and the investor in understanding how much money the company need and how they intend to return it.
Recognize your requirement
Before going out to look for deals, businesses must decide if they want a long-term or a short-term loan. Short-term loans must be repaid in less than a year, whereas long-term loans must be repaid in more than a year.
Furthermore, there are several forms of loans (asset-backed loans, corporate debt, term loans, vendor invoice financing, or simply a line of credit). Having a clear understanding of the type of credit your company wants to pursue can help it attract the best deals.
Examine the market for the best partner
Conduct a market survey and investigate the debt finance market. Learn what venture capitalists (VC), institutional investors, businesses, and financial institutions have requested. Going to a bank with a 400 credit score when their policy requires 550+ can cause more harm than good.
Understand all of your responsibilities
When working with an investor to raise loans, make sure your company understands the compliance, fees, and repayment restrictions. Calculate the cost of capital for your business. When lending to businesses, different lenders charge different costs. Processing fees, foreclosure charges, unused fees, interest rates, amortisations, and other expenses are examples of common charges.
Understand whether the interest rate offered to you is fixed or decreasing in order to make the best decision. Make certain that there are no ambiguities regarding repayment schedules.
Debt financing has helped firms grow enormously by providing simple access to working money, financing supplier chains, and funding business operations. However, efficiently raising debt is the key to overcome frequent obstacles organisations confront while raising loan.