Capital refers to assets or cash required by a business to provide goods and services to its customers. All businesses need capital to stay afloat. Business owners who lack capital will often to turn to equity capital or debt capital. They can each provide additional funding but they both are very different from one another. Read on to learn what debt capital is and much more.
What is Debt Capital?
Debt capital refers to fund or assets generated by borrowing from a lender. A business owner takes on debt to get capital. For example, conventional bank loans are debt capital.
Most business owners prefer debt capital over equity capital because they do not have to give up their business ownership. The downside of debt capital is that it can be more challenging to secure. New business may struggle acquiring debt capital because banks typically hesitate to finance a business that is lacking in their track record.
What is Equity Capital?
Business owner do not take on debt in equity capital. Investors purchase partial ownership in the business (equity) and the owner does not have to repay.
It is easy for businesses to acquire equity capital. Those businesses that are struggling to obtain traditional debt capital will look into obtaining equity capital. The downside of equity capital is that you need to forfeit part of your business and most small business owners do not like this.
Pros of Debt Capital
The following are some benefits of having debt capital:
- Maintain ownership: you can continue to own your business without interference. You become obligated to make the agreed payments on time.
- Tax deductions: the principal and interest payments fall under business expenses which are then deducted from your business’s income at tax season. Many business owners find this the most attractive benefit of debt capital.
- Low interest rate: low interest rates are also another pro of having debt capital.
Cons of Debt Capital
The following are some cons of having debt capital:
- Repayment: you need to make the payments even if your business fails.
- High interest rate: you may need to pay high interest rates depending on your business credit score, personal credit, and history with the lender.
- Cash and collateral: you may be asked to put up collateral to protect them in case you default on your payments. You need to make sure your business generates enough cash flow to be able to repay the loan.
Types of Debt Capital
Business credit cards
Business credit cards offer owners a line of credit easily. They carry interest charges if balances are not repaid in full similarly to a normal credit card.
Pros of Business Credit Cards
- Easy to qualify
- Build credit score
Cons of Business Credit Cards
- High interest rates
- High fees (late payments, annual fees, cash advance fees, etc.)
- Personal legal liability
Microloans are easy and small to obtain for small businesses. They are offered to businesses that require capital to begin or run their operations.
Pros of Microloans
- Low interest rates
- Idea for business with limited access to capital
- SBA can be an intermediary
Cons of Microloans
- Require good personal finance history to qualify
- Can be difficult to acquire
- Short terms
- Possibility of needing a personal guarantee or collateral
Small Business Administration Loans
SBA microloans are the most popular type of debt capital and can give up to $50,000 in funding. You need to just why you need the capital and the amount to qualify. You also need to show that you are trustworthy and are capable of repaying the loan.
Pros of SBA microloans
- Loans are processed quickly
- You receive the funds fast
- SBA funds can settle between different business costs and needs
- SBA loan forgiveness allows you to propose a reasonable amount you can repay
Cons of SBA microloans
- May take longer for an SBA approved loan to get approved and disbursed making it not a good option for those that need cash fast.
- Lenders can charge additional fees
- Can be difficult to qualify for
- Comes with spending restrictions