In simple words, debt financing happens when a firm wants to raise money to fulfill the capital expenditure by selling bills, bonds, and notes. This is when a firm is allowed to sell these products to individual investors or independent organizations. Therefore, whenever an individual receives the money from this investment, they become creditors. Simply put, it is also a promise that you will pay the interest or principal amount over a certain time. Debt financing lies between 5 to 30 years, which is dependent on the product being sold. Here, we will shed light on the disadvantages of debt financing:
You have to Pay Back the Debt Amount
If you have to make payments on debt financing products, it will be a stress-free experience since you will have strong revenue on your side. However, what happens if the sales of your firm eventually come down or you become bankrupt? Therefore debt will still be around in case something unexpected happens. Furthermore, if you delay making the debt payment, it will add more to your interest rate.
Some Lenders will Put Restrictions on How they have to Acquire the Money
Most businesses shy away from debt financing because it is not the ultimate best option for them due to the restrictions imposed. A firm will only receive money that will cover the important expenses and will not be invested in unnecessary areas. However, when the borrowing requirements are added to this process, it is hard to make the most out of this cash. Therefore, it is crucial for startups to look for other options.
It is Expensive
Debt financing has a higher interest rate as compared to what is being offered in the market for government securities. This is why it is a compelling option for some investors, but you’ll also have to dedicate a large part of your cash to the interest rate. Secondly, if you have received the council tax attachment of earnings already, it will be hard for you to adjust to the new problem. Your credit history will have a profound impact on whether or not debt financing is the right choice for you.
Collateral Might be Necessary
If your business has recently debuted in the market, you might want the company to provide secured collateral. This will be inclusive of cash apart from the assets. Therefore, in case you miss making a certain payment, your business assets might be at the risk of being confiscated. In fact, every lender will ask you and the stakeholders to guarantee the loan amount being paid back if the business has just begun.
It is Challenging
Some companies don’t witness massive improvement in their earnings for a long time. In fact, the number of their products and services being sold remains the same over time. The other time, they don’t have many opportunities to explore. Although, the bonds can be structured, and different debt financing options can be concerned. Debt financing entails equal installments over a certain time, which means that delayed payment will put the cash flow of the company at risk.
