May 31, 2020  
 
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Raising Money

 

Debt Financing

How do I get a small business loan for my business? Great question. If you are interested in debt financing, it's best to first have a solid understanding of what getting a loan entails and what the possible sources are for business loans.

As you probably know, debt financing refers to what we normally think of as a loan.
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A creditor agrees to lend money to you, the debtor, in exchange for repayment, with accumulated interest, at some future date.

The nice thing is that, in contrast to equity financing, the creditor does not obtain any ownership claim in the debtor's business. In other words, you don't have to sacrifice any ownership interests in your business. Plus, interest on the loan is deductible and the financing cost is a relatively fixed expense.

There are many sources for debt financing: banks, savings and loans, commercial finance companies, and the U.S. Small Business Administration (SBA) are the most common.

State and local governments have developed many programs in recent years to encourage the growth of small businesses in recognition of their positive effects on the economy. Family members, friends, and former associates are all potential sources, especially when capital requirements are smaller. To be sure, many great businesses were started with a "friends and family" financing round.

Traditionally, banks have been the major source of small business funding. Their principal role has been as a short-term lender offering demand loans, seasonal lines of credit, and single-purpose loans for machinery and equipment. It's a good idea to contact your banker and ask him or her what it would take to get a small line of credit.

However, banks generally have been reluctant to offer long-term loans to small firms. One vehicle for obtaining a long-term small business load is available from the SBA. The SBA guaranteed lending program encourages banks and non-bank lenders to make long-term loans to small firms by reducing their risk and leveraging the funds they have available. The SBA's programs have been an integral part of the success stories of thousands of firms nationally.

Banks aren't stupid. In addition to equity considerations, lenders commonly require the borrower's personal guarantees in case of default. This ensures that the borrower has a sufficient personal interest at stake to give paramount attention to the business. You can't just walk away from your business and walk away from your debt obligations. For most borrowers this is a burden, but also a necessity.

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