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Anthony Jaiyeola, founder of Risecap, the leading business finance consultancy firm, shares his thoughts on understanding debt financing.
In the ever-evolving world of business, having access to capital is a key component of sustainable growth. While equity financing can be a viable route, debt financing often emerges as a preferred choice for many small business owners. Understanding the intricate dance of numbers and narratives can help shed some light on the world of debt financing for small businesses. In this article, I’ll share the key things you should consider before undertaking debt financing and how you can evaluate if it’s the right decision for you.
Understanding Debt Financing
Debt financing involves borrowing funds from external sources with the promise to return the principal amount along with agreed-upon interest. From traditional bank loans and lines of credit to newer options like online lenders and crowd-funding, the avenues for debt financing are vast. Your choice should align with your business needs, repayment capacity, and the nature of your operations.
Many well-known start-ups as well as established larger companies have used debt financing for funding. In 2014, Square, founded by Jack Dorsey, received funding through debt financing. A Square spokesperson said at the time: “Securing access to low-cost capital always makes financial sense, even for a well-capitalised company like Square.” ¹
Established companies have also used debt financing to fuel growth and expansion. Amazon secured a debt financing loan at the beginning of 2023, to “support capital expenditures, debt repayments, acquisitions, and working capital needs.” ²
Further well-known companies who have reportedly used debt financing include Dropbox, Coinbase and Airbnb.³ This shows that in the dynamic landscape of business, the strategic use of debt financing has proven to be a versatile tool for both pioneering start-ups and industry stalwarts alike.
Advantages of Debt Financing
Once you understand what debt financing actually is, the next question you’ll likely ask yourself is what the benefits of debt financing are. Embarking on this strategic and pivotal decision can provide a number of benefits to SMEs, from business control to financial perks. Debt financing stands as a versatile and expedient resource for SMEs navigating the complex landscape of financial sustainability and growth.
It’s also worth pointing out here that without a doubt, your time is best spent in or on your business. This is why working with a brokerage firm, such as Risecap, will enable you to open doors not previously considered. There’s more than one type of debt financing and sometimes, the first application doesn’t come off. This is where it pays to work with someone who can think outside the box, reevaluate your initial proposal and then find the thing that makes your request different. By changing the goalposts, if you will, you can then re-apply for an alternative product which can deliver the objectives you desire.
Some key advantages you should explore to understand how debt financing can help your business are:
- Retain Ownership: One notable benefit is the ability to retain ownership, allowing business owners to maintain control over key decisions without needing to share authority, unlike equity financing where ownership stakes are often relinquished to external investors. This is essential in the ever-changing world of business. By retaining control, entrepreneurs can align company strategies with their unique insights and long-term goals giving them the ability to flourish and address relevant industry challenges.
- Tax advantages: Debt financing provides tax benefits, as the interest payments on the borrowed amount are typically tax-deductible, offering potential cost savings for the business. Other options such as equity financing do not offer direct tax advantages, creating an argument that debt financing can be a more strategic avenue for companies. By reducing their taxable income, these enterprises are also able to allocate more resources toward operational needs, innovation or growth initiatives. More broadly, debt finance can enhance the financial health of SMEs.
- Credit building: By consistently repaying loans, SMEs can enhance their creditworthiness. This opens up opportunities for future financial transactions and partnerships. This financial badge of honour becomes a compelling asset when seeking additional funding, whether it be for expansion initiatives or strategic investment, you can show lenders and investors a paper trail of responsible financial management through debt financing. This credibility could also lead to fruitful partnerships, overall contributing to sustainable growth for the business.
- Speed: Lastly, the speed of acquiring funds through debt financing is a compelling factor for SMEs. In urgent cases, funds can be secured in as little as 24 hours, with the current market average being 1-2 weeks. This quick accessibility to capital enables SMEs to seize timely opportunities or address immediate financial needs, contributing to their overall financial flexibility and resilience.
Things to Consider
Of course, there are always important considerations to take on for a company considering funding, and debt financing is no exception. There are intimate nuances for every business and no such thing as a one-size fits all solution. By examining the specifics of your company’s needs, you can aim towards the debt financing solutions most aligned with your growth trajectory.
Some key considerations which shouldn’t be ignored and factored into your decision-making process are:
- Interest: Companies always need to account for the interest rate. While a low interest rate might look appealing, astute SMEs must recognise the importance of delving into the intricacies of any lending agreement. Scrutinising the fine print is essential to unearthing any hidden charges or fees under the iceberg, potentially impacting the overall cost of the loan. This diligence ensures that the allure of a low-interest rate does not turn into a financial pitfall over time.
- Repayment Terms: Equally important in the realm of considerations is understanding the flexibility and terms of repayment. SMEs must ascertain if they can pay off the loan early without penalties. If the opportunity to retire the debt ahead of schedule arises, a company could make major potential interest savings.
- Collaterals & Personal Guarantees: Beyond the numerical aspects, some lenders might require collateral or a personal guarantee as a safeguard against default. SMEs must take time to undertake a comprehensive examination of these implications and be comfortable with the associated terms. This due diligence leads to making an informed decision about the potential risks and consequences of these collateral obligations.
Conclusion:
When beginning a debt financing journey, SMEs must consider this sentiment; closed mouths can’t be helped. Engage in a dialogue, ask any questions, and seek knowledgeable guidance. Whether you’re navigating the complex waters of finance for the first time or you’ve done it a hundred times over, a fresh perspective can often shine an essential light on overlooked details. Debt financing, when leveraged correctly, can be a powerful tool to catalyse your business’s growth. It offers the promise of capital without diluting ownership. However, like all tools, it’s about how you use it. If you’re empowered with the right knowledge and insights to make the best financial decisions for your enterprise, debt financing could lead to a new era of sustainable growth and innovation for your business.
About Tony Jaiyeola
Anthony (Tony) Jaiyeola is the founder and director of Risecap. As a qualified financial advisor, Tony recognised an opportunity to bring clarity and simplicity to businesses seeking funding.
Back in 2014, Tony found himself needing to raise capital for his growing business. He and his business partner were in a hurry to capitalise on a fantastic inventory discount, only to discover that the funding process was anything but smooth. The experience left them feeling frustrated, wanting more and instigated the idea for Risecap which launched in 2018.
Risecap has raised £60m in debt funding over the past five years, helping hundreds of businesses in the process.
Tony is committed to being a human-led company, leaning heavily on empathy and building trust in the process – something which has become elusive in the world of finance.
Tony hosts the podcast series ‘The Risecap Recap’ which covers financial education, aspiration, freedom, relationships and other subjects helping people to embody the impact we wish to see in the world, beating the odds and figuring out how to rise to the next level.
¹ Square Also Just Got Hundreds of Millions in Credit — So What’s Up With Debt Financing? https://www.vox.com/2014/4/6/11625318/square-also-just-got-hundreds-of-millions-in-credit-so-whats-up-with
²Amazon secures $8 billion term loan, Reuters. https://www.reuters.com/business/retail-consumer/amazon-secures-8-billion-loan-2023-01-03/
³Startups where debt financing was a great option to not be diluted and keeping equity https://www.gilion.com/basics/debt-financing-for-startups#:~:text=Debt%20financing%20has%20been%20a,%2C%20Uber%2C%20Spotify%20and%20Airbnb.
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