Last week, we discussed how to fund business operations and projects. In a very broad sense, funding options can be divided into investor financing and lender financing. This week we will look at how to access two types of lender financing – debt financing and loans.
This is something we have already discussed in our blog ‘Debt as a source of financing’. To summarise, debt financing, usually referred to as debt lending, is the process by which a company raises money from investors by selling debt instruments like bonds or notes. The investors that buy a bond a company sells are referred to as lenders and the proceeds of the transactions are utilised by the company as capital. Debt financing is comparable to borrowing money in that there is a debt finance contract that specifies the terms of the loan, including the interest rate and time frame for repayment.
Loans may be deployed in two different ways: secured loans and unsecured loans. These two don't significantly differ from one another. Unlike unsecured loans, secured loans are lending options that need collateral. Secured loans have a lot of benefits which include getting a loan with a higher borrowing cap, a cheaper interest rate and a longer payback period. Depending on the loan, such as a mortgage, you may also be eligible to deduct the interest you pay from your taxable income. However, you run the danger of losing your collateral should you stop making your payments.
How do you access secured loans?
Research for potential lenders - By conducting research, you may compare the rates and charges of numerous lenders. Choose the one whose services and products align- with your company’s objectives and goals.
Start a relationship with the bank - Establishing a relationship with the institution you would like to obtain the funds from is the first step in obtaining a secure loan. Open a bank account if you don't already have one. Some banks require that you have maintained a relationship with them for at least six months.
Evaluate your credit - Before applying for a loan, you should always review your credit history, i.e. conduct a credit report check. Knowing how qualified your credit score is, is still vital even if secured loans may have less stringent and strict credit standards than unsecured loans. This is because getting a loan mostly depends on your credit score.
Collateral asset valuation - As the amount you may borrow with a secured loan is often determined by the value of the asset you plan to use as collateral, get an appraisal or check the projected resale value of the item you intend to use as collateral.
Apply officially - Prequalification is a service provided by multiple lenders that allows you to find out which loans you're qualified for without having your credit report impacted. It is recommended to obtain prequalification from at least three different financial institutions. Apply formally for the loan once you have received prequalification from a financial institution. In contrast to the process for qualifying for an unsecured loan, secured loan providers may request an appraisal to verify the value of your collateral before issuing the loan.
Advantages and disadvantages
The advantages include it is less expensive than equity financing, your company will still have full ownership, the debt repayment is tax deductible, and it raises your company's credit score while the disadvantages include payments must be made on time regardless of whether the company is profitable or generating money; the interest rate may be on the high side and having too much debt might scare away potential investors.
If you require advice and support on how to determine which choice from the list above best meets your company's objectives, please email our finance experts firstname.lastname@example.org