Pros and Cons Associated With Debt Financing for the E-commerce Business Owners

When you are borrowing money from outside sources, and you are promising to return this principal along with an agreed percentage of added interest, you are taking on debt. Debt is known to have numerous negative and unwanted implications, but the start-up e-commerce businesses need to acquire debt so that they are capable of financing the various business operations. Even if you look into the records of the healthy balance sheets of big corporations, you will find out that it includes a certain level of debt. Debt is also known as leverage according to the financial terms. It is true that banks are considered to be a popular source of the debt financing method.  However, you can also issue debts from private companies or your family members or friends. Businesses that start small normally do not qualify for the traditional loans, as stated by www.huffingtonpost.com.

Benefits associated with debt financing

Given below is a list of the benefits that are associated with debt financing.

• Maintaining ownership

You start becoming obliged to make the payments that you have already agreed, in accordance to a proper time, when you are borrowing from traditional financial institutions or other lenders. However, this is undoubtedly the end of the obligation. You still have the right of running your e-commerce business in accordance with your will and wisdom, without anyone else interfering in the decisions that you make.

• Tax deductions

This is one of the greatest attractions for debt financing. In most of the cases, the principal, as well as the interest payments, are referred to as the business expenses, particularly for the business loans. This is why they can easily be deducted from the income of your business at the time of tax. It helps in thinking that the government is your partner in the business, along with the ownership stake of 30% or whatever the tax rate of your business is.

• Low rates of interest

You should be capable of analyzing the effect of the deduction of tax on the interest rate levied by the bank. If you see that your bank charges 10% of the loan, and if your government is charging 30%, there is always a benefit to taking loans that you are capable of deducting.

Disadvantages associated with debt financing

Given below is a list of disadvantages that are associated with debt financing.

• Repayment

The only obligation that you will have to your lender is making payments but you also have to pay even if you see that your business is failing. The lenders will have the capability of claiming for the repayment even before the equity investors, in case if you are being forced towards bankruptcy.

• High rates

After the calculation of the discounted rate of interest from the tax deduction, chances are that you will face a high rate of interest because of the macroeconomic conditions, the history that you have with your bank, the credit rating of your business, as well as your credit history.

• Impacts on the credit rating

It is true that it might look attractive if you are bringing on the debt when you see that your e-commerce business requires money. However, all the loans are going to be noted on the credit report of the business, and this report is going to affect the credit rating. The more amounts that you are going to borrow, the higher the risk will become to your lender. So, you will have to pay a high rate of interest on the subsequent loans individually. You can go through the debt consolidation loan reviews on the internet as well.

• Cash as well as collateral

As the owner of an e-commerce business, even if there are plans of using the loan for investing in an asset that is extremely important, you need to ensure that the business is generating a sufficient flow of cash by the repayment time of the loan. You may also have to put up collateral for protecting the lender in case if you are defaulting on the payments.

Alternatives that you can opt for

Given below is the list of the alternatives that you have the option of opting for.

• Equity financing

Equity financing is known to involve selling the shares of the e-commerce company to the investors who are interested or you are putting your personal money for the benefit of your company. This is a great alternative to debt financing.

• Mezzanine financing

This tool is known to offer unsecured debt to the businesses and there is no requirement of equilateral. However, the interest rate is high and it ranges from twenty to thirty percent. There is a catch associated with this. The lender holds the right of converting this debt to equity, in case if the business defaults on the payments.

Mezzanine financing is known to appeal to the entrepreneurs because it is known to offer liquidity. Moreover, the bank that issues the loan will not want to be the equity holder, despite the fact that the debt amount will be converted to equity. They do not look forward to controlling the company.

• Hybrid financing

A number of businesses turn to the combinations of equity and debt financing in order to fund their entire business venture. It is crucial for a business to determine the perfect combination. This is also a great alternative to debt financing that most of the e-commerce businesses are opting for.

When can you use debt financing?

A lender normally seeks installment payments on the loan right after the money is being lent. It means that you are going to require cash for making the payments in short orders. It has been observed that thriving businesses normally find themselves short of cash when the amount is tied in equipment or in case if the customers are not paying.

Conclusion

It is extremely important to know about the pros and cons that are associated with debt financing. As an e-commerce business owner, it will be easier for you to deal with your debts if you have a proper understanding of debt financing.