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Debt Financing for Small Businesses

Filed under Getting Financing. Fact checked on May 24, 2012.

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Debt financing allows you to find funding for your business while maintaining complete control and ownership of your business.

Debt financing refers to what we normally think of as a loan. It boils down to a couple simple components:

  1. a creditor agrees to lend money to you in exchange for repayment, with accumulated interest, at some future date
  2. the creditor does not obtain any ownership claim in the debtor's business. 

Debt financing is attractive to many small business owners for good reason:

  • you do not have to sacrifice any ownership interests in your business
  • interest on the loan is deductible
  • the financing cost is a relatively fixed expense

Understanding Debt Financing Options

Throughout this article, we're going to examine the most important aspects of debt financing that you, as a small business owner, need to know, including:

  • Selecting a bank or other conventional lender: What are your options? Where are you most likely to obtain the best loan for your business?
  • Common types of bank loans: What types of loans are available? What are the practical considerations you'll encounter?
  • Direct and indirect costs: What expenses and demands should you expect of a bank loan?
  • What banks look for: Learn about credit history, collateral, cash flow and character as they relate to different kinds of small business loans, and the documents you'll need to secure a conventional loan.
  • Asset-based financing: Discover how accounts receivable and inventory can be used as collateral.
  • Leasing: Consider renting as an alternative way to finance equipment purchases.
  • Trade credit: Take advantage of suppliers that provide an easily available way to supplement conventional borrowing.
  • Life insurance companies: Use your existing policy can be a source for low-interest policy loans.

Selecting a Bank or Other Lender

You can investigate a number of institutions that offer small business loans, although each type of lender may be better suited to different lending situations.

  • Banks include traditional savings banks, savings and loans, and commercial banks, and are generally the first place small business owners think of when looking for institutional financing.
  • Credit unions can offer generous terms to their members, but make mostly consumer loans.
  • Consumer finance companies may be willing to make higher-interest loans to higher-risk small business borrowers.
  • Commercial finance companies may be worth considering if you need a loan for inventory or equipment purchases.

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