Debts can be fun when you are acquiring them but they are not when you retire them
Most of the start-ups face the problem of deciding how they will acquire capital for their business. And these days almost every other start-up chooses debt financing. Debt Finance is the money that you borrow from banks or other sources and you have to pay it back in the agreed period along with the interest amount. The common forms of this can be loans from banks, financial institutions, or bonds. It is a great source of financing but only if you are prepared for everything that comes along with it. The timely interest payment can be a burden if you are not having a good cash flow.
Here is a list of disadvantages of Debt Financing that can affect any company-
Need a regular income
When you opt for debt finance you need to make sure that you are having a regular and a good amount of cash flow into the business. This is because you have to pay a certain amount of interest to the lender. And this has to be paid along with a certain principle amount. So if you think you will not have a regular income then you can be in trouble. There can be certain factors determining whether you will have a good cash flow or not like the demand and supply in the market, preferences of customers, etc.
Effect on credit rating
A good credit rating will be beneficial for your company. You can easily get a loan next time when you are looking forward to implementing growth strategies. But if you are lacking in maintaining a good plan to pay back your lenders then they will not give you any loans the next time. As they will not be able to trust you again. This will decrease your credit rating which is not at all beneficial for your company.
If you have taken a loan from your family member or a friend then you will not be facing this problem but banks and other financial institutions ask for collateral. A collateral is a security that the lender asks for when he is providing you a loan. You have to keep the assets of your company or even your items as collateral. This can be a risky thing because if you fail to repay the loan you can lose everything.
Impact on ownership
Some lenders can put limitations on how the money will be used in the business. When they provide you with a loan they make sure that the amount comes back to them along with the interest. So if they see that you may not be able to repay the amount, they can put some restrictions. They can even make decisions for your business without having any word with you. This is one of the major drawbacks of debt finance you may come across.
It is a situation when a borrower is not able to pay the amount of the loan and files for bankruptcy. It is legal action taken by the borrower to free itself from the burden of debts. All the assets of the company can be used to repay the loan to the creditors. The debt amount is calculated and according to that assets are taken out. People think that it is a good way to a fresh start but it is not as easy as it looks. After this, there is a possibility that you may not get loans anymore. You do not know what you can lose because you can even lose your home. Your personal belongings like jewelry, car, furniture, appliances can be sold out. Different countries have different procedures that they follow.
If you are planning on raising capital through debt finance, keep in mind all these limitations as you do not want to lose everything. Make a suitable plan and decide how you are going to pay the amount when your business will not make enough money. Certainly, you will not always have profits. The state of the market keeps changing and you have to cope with it. In the first few years of your business, the chances of bankruptcy are the highest so think twice before making any choice. You do not want to lose everything at the start so work wisely.