EXPLAINED: Structured Debt Finance versus Equity
Trade Finance Global explains some of the key differences between structured debt finance and loans versus taking on other forms of financing such as venture capital or private equity to finance the growth of a business.
The fundamentals of business will generally remain, businesses typically need to spend money or invest in their products and/ or services in order to make money and turn profits. Sometimes a large amount of capital is required in order to acquire the necessary equipment, staff or services or to expand the business in order to make it a viable customer proposition (and business model). Unfortunately for most businesses, acquiring a large amount of cash in a short period of time is challenging so options are limited. A business could find an equity investor, but the chances of finding an investor who shares your business vision and doesn’t want a crippling amount of equity, all in a short amount of time, are quite slim. That’s why many people believe debt financing is a better option for financing projects or assets for the business. However, debt financing isn’t perfect, and there are risks that you should be aware of. What are the pros and cons of debt financing, and what should you be looking for before you take on debt?
Pros of structured debt finance
The biggest pro of taking on debt in order to finance your projects is the financial freedom it gives your company. With new funds, your business will now be free to pursue expansion projects that were previously too expensive or acquire much-needed capital that can increase productivity. Your business should already have a plan in place to efficiently use your new funds, meaning you will be able to use your new funds in a way that allows you to increase your revenue and overall profit. This will allow you to not only pay your debt back eventually but may even allow you to fund similar projects in the future without even taking on any debt. Sometimes, all you need is a little extra nudge in the form of expendable cash in order to get your business fully operational. In addition, a major advantage of debt financing is you don’t have to worry about any investors taking equity. This means that as an owner, you won’t need to satisfy investors with stake in your company and you can completely avoid the inevitable power struggles that occur. Debt financing gives you the freedom to pursue your vision for the business without compromising with any other new owners or investors.
- No equity or stakes given out
- Shorter time period (from requesting to issuance)
- Revolving debt facilities available
Cons of structured debt finance
The major con of debt financing is the large amount of money that your business has to pay back to the lender. This sum of money typically includes some sort of interest, meaning that you will be paying back more than you actually borrowed. In addition, taking on too much debt could bring financial doom to a company. Some companies take on debt with an adequate plan to use the funds, meaning the company can’t raise revenue and profits enough to maintain the business’s operations and pay back the loan. Other companies may have the perfect plan to use funds but an unforeseen disaster or market shift may leave the company unable to pay back the loan in time. For example, a business may take a loan to purchase capital in the form of homes for sale in Salt Lake City. However, a multitude of disasters that are out of the business’s hand could occur and could lower the effectiveness of the business’s new capital. Taking on debt is extremely risky, and sometimes even the most careful planning can’t mitigate that risk.
- Interest repayments required
- Could strain a business
- Security often required (e.g. personal guarantees or a mortgage)
- Can affect the creditworthiness of a company