Understanding Debt as A Financing Option for Starting New Businesses

Understanding Debt as A Financing Option for Starting New Businesses

Understanding Debt as A Financing Option for Starting New Businesses

Budding entrepreneurs often fail to execute their strategies for lack of proper capital. Hosting businesses based on reseller hosting, drop shipping businesses, e-commerce ventures, and remotely delivered services – all kinds of business models depend on some sort of financing to get off the blocks.

Starting a new business is no easy feat, not everyone has that kind of money required to get a product on store shelves and app marketplaces. However, what most people fail to recognize is that it is not just liquid cash but also credit that together forms the total capital of any profit making venture. Read on to know all about debt financing and reasons why it is a great idea for your start-up venture:

Need For Debt Financing

Every profit-making organization, no matter how big or small requires a fair share of additional capital set aside as a reserve for battling emergency situations. This reserve fund can be collected either through debts or by convincing investors to contribute to your business.

Inexperienced entrepreneurs often face the dilemma of choosing the ideal funding option for their enterprise. Equity or debt? That is the million dollar question. Debt financing is when you apply for loans and pay it back with interest. You are free to spend the money the way you want, unlike equity investment where the investors have a say as well.

What Option Do I Have?

Debt plays an equal role in the capital of any company. For, an entirely equity dependent enterprise can be tough to manage. However, that said and done, counting solely on debt funding is not a very smart option either. The trick lies in finding the perfect balance between the two. You need to look at your credit standing and financial credibility before you apply for a loan. Let us look at the many debt financing options available in the market that you can use for.

SBA-Backed Loans

SBA or small business administration is an organization that offers loan programs to various budding businesses and start-up holdings. Now, to get an SBA loan, you will have to apply for it through a local bank. The bank acts as a middleman bringing together the two parties on a common platform. These loan programs support both ambitious manufacturing undertakings and small-scale holdings by offering robust financial solutions and marketing plans. The SBA loans are governed by a strict set of rules that all the lending partners must adhere to. Most SBA programs include government banks and community banks that back you up in the case of bad debts.  

Asset Based Lenders or ABLs

Asset backed lending firms offer lucrative loan programs for start-ups that want to accumulate instant capital by mortgaging the fixed property of the company. However, ABLs cover a wider spectrum that most entrepreneurs fail to recognize. These undertakings usually provide loans against inventory, heavy-duty equipment or a company’s bills. The company predetermines the amount of money granted against a particular asset and mutually agreed upon by both the parties. Also, the interest rate varies according to the size and scale of the financial organization.

Factors

Factors are somewhat similar to ABLs loan program and offer cash against company assets and bills receivable. As the accounts receivables determine the credit position and credibility of the company, it is an essential part of the factors loans plan. Now you can apply for the loan through a bank or contact the Factor program through a “lockbox.” The interest rates, however, are a bit high when compared to other debt financing options. It charges one percent per month on the loan amount as interest (an expensive alternative to the conventional one percent rate charged annually).

Revenue Based Financing

Tax based loans or RBLs were particularly beneficial for growing companies that lack hard assets and substantial capital for kick-starting their venture. As per the plan, the companies receive an amount that is about 10% of their previous year earnings. Therefore the market position and revenue earned by the business determine the advance money you get. E-commerce websites, IT companies, and the entertainment industry are good candidates for the RBL based loan programs. However, RBL funds are not granted to companies that fail to earn a gross profit margin of 50%, a very unrealistic yardstick that only a few start-ups manage to achieve.

Microloans

Microloans are perhaps the best solution for first-time entrepreneurs who need the necessary capital for buying goods and other primary assets of the company. It is a lucrative financing solution for service based enterprises where you would require liquid cash for establishing the framework of the organization. Microfinance is a growing concern that also offers newbies cooperative training programs in marketing, management, accounts and sales. A friendly and supportive debt financing solution, microloans are a hit among young business men who have a low credit score.

The Bottom Line

Debt financing is a smart way to stock up some reserve and stretch a company’s working capital. This surplus comes in handy especially in the case of bad debts and delayed payments.