While there are several options in terms of structuring a debt financing, the end result is basically a business loan with the primary obligation being that the borrowing company make scheduled payments of principle and interest. The biggest advantage of raising capital through debt instruments is that the lenders do not take an ownership stake in the business, as is the case in an equity offering. Shareholders brought in through an equity offering can bring a variety of headaches, including:
- Demands for inclusion on the company’s board of directors, if the equity stake is large enough
- Demands for enhanced voting rights
- Demands for information on company progress
Debt financing provides the best solution for business owners who want to retain full control of their company and for businesses generating enough cash flow to service interest payments without restricting day to day operations. Financing via debt also allows revenues and profits to be retained while capital raised through a debt offering can be deployed for the salaries of new employees as well as purchases of equipment and inventory.
Debt financing does have its drawbacks as well, with the primary disadvantage being the burden of servicing the loan. Another issue with structuring a loan is that a vast majority of lenders will insist that company assets such as equipment, real estate holdings, etc. be pledged as collateral to secure the loan.
Depending on the consistency of a company’s cash flow, interest payments on debt can erode profits and pull capital away from daily operations. If the debt service becomes too burdensome, some lenders will allow for a re-negotiation of terms but may insist that additional assets be pledged as collateral against the loan.
Debt financing provides several advantages for raising capital but it is not the perfect solution for every company. Debt financing professionals such as the team led by Dmitrij Harder at Solvo Group can help to determine whether debt financing is the best solution for a business and, if so, define the best loan structure to minimize risks and deliver the most benefits.