According to the U.S. Small Business Administration, newer businesses access capital from many different sources. More than 70% will use personal savings or another form of self-funding, while other sources include business loans, credit cards, venture capital, grants, and more. Debt financing is a traditional means of obtaining capital by borrowing with a repayment agreement. Roughly 87% of small business owners report they use some type of debt financing.
Understanding Debt Financing
Firms of all sizes often need funds for working capital and expenditures. To finance these operations, businesses often turn to two primary financing models: debt financing and equity financing, which involves giving up some ownership and control in a company in exchange for capital.
In debt financing, borrowers receive investment capital with the condition that they will repay the principal – the amount borrowed – and interest to compensate the lender.
Loans associated with debt financing may be secured or unsecured. A secured loan involves some form of collateral that provides some security for the lender. If the borrower is unable to repay the loan amount, the lender may use the collateral to recoup losses. One example is a mortgage loan where the lender uses the home as collateral. There are other types of securities that also reduce the risk for the lender.
More commonly, however, unsecured loans have no assets attached to them. A credit card is a perfect example of an unsecured loan.
A loan guarantor is a third party that contractually assumes the obligation to “guarantee” the repayment of a loan in the event that the borrower can’t. A newer small business will often have an insufficient credit history to satisfy the lender. In this situation, a credible guarantor will improve the borrower’s ability to obtain capital.
A cosigner is a guarantor who is needed to obtain approval for a loan. A cosigner is different from a co-borrower, but both are assuming the risk. A co-borrower has some shared interest along with the primary borrower, while a cosigner does not enter the agreement with the intentions of making the payments to satisfy the debt.
RevTek Capital does not typically require guarantees from its borrowers. We would most likely want you to validate the information provided and ask that you don’t commit fraud, misappropriate funds, or embezzle. We don’t want to punish a business owner for failure but take calculated risks that should help entrepreneurs reach their long-term objectives.
Understanding Equity Financing
An alternative to debt financing is equity financing, which involves issuing lenders some ownership of the business. Corporate entities often do this by issuing shares of stock. The investor providing an equity investment hopes to see their share of ownership increase in value over time as the company grows.
One drawback from the owner’s perspective is they will be relinquishing some control to investors that have an ownership interest. Companies that rely heavily on equity financing may have less flexibility to independently make moderate to large business decisions. There may be approval processes put in place, such as when potentially adding employees or contracting with vendors.
Although this may seem like a very undesirable situation, the majority of large companies will require equity financing to fund their operations at some point.
Those who do not wish to surrender any management control to a lender often favor loans. Bankers do establish relationships with those they finance, but they are less likely to seek decision-making control in the business. Borrowers seeking financing may consider looking into several options from different lenders to compare.
The repayment arrangement of a loan tends to be classified into one of three potential categories:
• Short term: These are generally in the range of six to 18 months
• Intermediate-term: Typically a range of one to four years
• Long-term: Any period that exceeds four years
Other Potential Securities:
When obtaining loans for your business, lenders will often require you to provide collateral. There are a variety of assets that you can set up for security for your loans.
• Invoices: A company’s accounts receivable are generally considered as viable. This includes any invoices that the company is awaiting payment on. Lenders advance approximately 60 to 80% of the value of accounts receivable.
• Equipment: In what is called a chattel mortgage, a lender will view a company’s equipment, such as items used in manufacturing or production, as collateral. You can expect the collateral to equal roughly 60% of the equipment’s value
• Inventory: This usually equals approximately 50% of the value of products that are in-stock and available for sale.
• Real estate: Lenders generally view 90% of the value of the real estate as collateral.
The hard part for many SaaS, PaaS, and other recurring revenue businesses is that they do not have the collateral mentioned above, and are therefore not qualified for bank loans. Lenders like RevTek Capital are able to quantify the assets of the business by analyzing the company’s technology stack and customer revenue streams.
Considerations When Choosing a Lender
A company that is seeking financing may place considerable emphasis on the speed in which a lender can complete the process. This is particularly important when you are looking for a quick loan.
When looking to obtain capital fast, many business owners consider using a credit card. A potential drawback is that credit cards may charge higher interest rates and the availability of capital may be limited. The longer that you will need to pay the debt back, the more interest you will have to pay.
What is Tax Deductible?
For tax purposes, the interest on debt financing loans are viewed as tax-deductible business expenses. The interest that you accrue will generally reduce your tax liability. This applies as long as the funds are used exclusively for business purposes. To be eligible for tax deductions, there must be a written, legal obligation that exists to repay the debt. Talk to your CPA about the tax implications of a debt facility.
Most often, a company seeks financing for the purpose of boosting its working capital, which is calculated by subtracting the company’s liabilities from its assets. Most business experts and investors consider working capital a good indicator of the financial strength of a business.
Often those who lack working capital will experience problems with cash flow. Timeliness is a significant factor when it comes to working capital. For instance, cash flow problems can arise if you have a slow-paying customer and expenses such as payroll or loan payments.
Established Provider of Growth Capital Solutions
RevTek Capital is a lender offering emerging businesses’ debt that allows them to grow, without giving up big chunks of equity to outside investors, to support their growth. We partner with dynamic SaaS, PaaS, MSP, Cyber, IoT, and other recurring revenue businesses in various industries to assist them with obtaining the working capital they need. For additional information, please Contact Us today.