What is debt finance?
Debt finance is when a business borrows money – this could be in the form of a loan, or an overdraft – and agrees to pay it back, with interest, over a period of time.
What are the advantages to debt finance?
- Debt finance provides a straightforward and simple way for businesses to access finance.
- Unlike equity investors, debt finance providers don’t have a say in the running of the business taking on the debt. They only get involved if payments are not made on time or if there is a breach of the finance terms and conditions.
- Once the debt is repaid, agreements with the finance provider are complete – the businesses’ liability is over.
- Interest on debt finance is tax deductible.
What are the disadvantages of debt finance?
- Many debt finance providers require assets of the business, or a personal guarantee from the director, as a form of security if payments can’t be made. If a business is unable to keep up with repayments, the lender can seize the asset they have security over.
- It’s always important to read the terms and conditions of any finance agreement in detail to ensure they can be met. There may be additional fees or a variable interest rate to consider.
- Ease of access to debt finance can be an issue for some SMEs, particularly in a competitive market where there are lots of lenders to choose from. Too much debt can impact a business’ profitability and valuation.
Types of debt finance
- Bank loans / overdrafts
- Family and friends
- Leasing (borrowing to buy specific equipment or machinery)
- Invoice discounting (borrow against sales)
- Peer-to-peer (e.g. crowdfunding)
Who provides debt finance?
- High street banks
They often provide favorable interest rates.
- New, online challenger banks
Approval and funding can be awarded in as little as 24hrs.
- Peer-to-peer lenders
Peer-to-peer (P2P) platforms match investors with businesses that are looking to borrow funds.
- Specialist debt/loan providers
Community development finance institutions provide a more personal approach compared to high street lenders, by understanding the individual needs and requirements of each business.