What is debt finance and what are the benefits?

18/04/2023.
Debt can sound daunting for business owners but actually can be a cost-efficient way of obtaining the finance required in the short to medium term to realise growth and expansion plans.

What is debt financing?

If you’re considering refinancing any existing debt to make it cheaper, raising funding to support investment in the business, or using the capital to facilitate a sale of shares or dividends, this may be an option for you. It involves borrowing money from a bank or other lender (e.g. a private debt fund). Depending on the amount you’re looking for and the asset base of the business, it could be either a secured or unsecured loan.

What are the benefits?

When using debt financing, you will take out a loan or debt facility from a financial institution or bank and be obligated to make payments of interest and capital, in accordance with the agreed schedule. Most loans will not affect your ownership of the business, as long as you make the repayments on time. You will be in control and know exactly how much you need to pay which can help with budgeting and future planning.

Depending on the status of your business, you may be able to achieve a loan that has a low-interest rate. However, if you have struggled historically to borrow money from your bank, there are plenty of other options available. It’s important to not get trapped in a cycle of borrowing so make sure any deal you go into is transparent. If you are unsure, always seek advice.

Having good business credit is essential if you’re looking for low-cost, long-term debt funding. Therefore, it’s important to build your business credit as this will help establish more favourable terms with lenders.

Another benefit of debt financing is that it may attract tax deductions. As appropriate debt finance is typically classified as a business expense, the interest payment on that debt could be deducted from your business income taxes. Overall, it can reduce your net tax obligation at the end of the year. Again, make sure to seek advice from a tax professional to make sure you are following correct protocols or ask general questions about how the debt will affect your tax obligations.

What you need to consider when obtaining debt finance?

Although debt finance can provide a great source of finance, it's crucial to take into account its limitations and potential risks. Some of the areas to consider include:

  • Interest Payments: Debt finance comes with interest payments that increase the cost of borrowing. High-interest rates can have a significant impact on your cash flow and will likely take priority over any dividend payments.
  • Default Risk: Taking on too much debt can potentially put your business at risk of default, especially if you are unable to make payments on time. This can lead to the seizure of assets and legal action.
  • Repayment Schedule: Debt finance often comes with a repayment schedule that can be rigid and inflexible. This means you may have to make payments even if your business is experiencing a temporary cash flow issue.
  • Limiting Access to Funds: If your business already has a high level of debt, lenders may be hesitant to provide additional financing. This can limit your ability to access funds when you need them.
  • Negative Impact on Credit Score: Failure to make debt payments on time can negatively impact your credit score, making it harder to access financing in the future.

What’s next?

Understanding the funding landscape can be complex but is essential in order to make your goals achievable. There is a growing market of various finance options so it’s wise to get advice first to see which is best for you and your business. With this in mind, business owners will need to also understand the tax allowances and implications of using any debt and extracting funds.

Get in touch

If you’d like to know more about debt finance and how our team of deal advisory, tax and financial planning advisors can assist, please use the contact form below.

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How we can support you if you are looking to secure debt financing

Our deal advisory, tax and financial planning advisors can support you through all stages of debt financing. We will work with you to:

  • Understand your key objectives and timing so that we can help advise on the right debt structure
  • Help you approach and engage with the right lenders for your business using our extensive banking and private debt fund network of relationships
  • Understand your objectives and approach to find the right partner, not only based on financial metrics but non-financial ones as well, such as personality, sector experience and house style
  • Prepare marketing materials that will position your business in the best light to potential lenders, including a business plan and information memorandum
  • Help you prepare the business for the process, including gathering financial and other information to ensure you are ready for a potential investor’s due diligence process
  • Understand the future cash flows of the business, using our financial modelling experts, to help you compare and contrast different lending offers to understand the impact on your equity value, your ability to service the debt, overall cost of the borrowing and the key risks
  • Design a bespoke process and manage it closely from inception to completion, liaising with the various legal and accounting advisors, creating competitive tension amongst lenders, and minimising the burden on you as you continue to run your business
  • Advise you and negotiate on your behalf all the key elements of the transaction to ensure you get the best deal possible
  • Advise you of your potential tax exposure for any relevant transactions, both for you personally if appropriate as well as the business to ensure you have clarity over your net proceeds from any transaction
  • Undertake a thorough exploration of your individual circumstances if appropriate as well as the business in order to identify and consider any tax reliefs that may mitigate your tax exposure and ensure any tax traps are understood and navigated in order to provide a bespoke tax plan as part of your strategy
  • Advise you on alternative deal structures to ensure tax efficiency, where appropriate
  • Manage and obtain relevant clearances from HMRC on your behalf, where appropriate
  • Advise you of your reporting requirements to HMRC in order to minimise the burden and give you peace of mind
  • Calculate the level of capital required from the financing to meet your objectives and provide security, using sophisticated cash flow forecasting tools. This helps you understand what is needed and what is aspirational. For example, could you raise debt capital to de-risk your personal objectives while retaining the potential for growth to meet aspirational targets?
  • Advise you on how to invest the sale proceeds to meet your objectives, including a review of existing investments and pensions to ensure they are used to best effect
  • Work with you in advance of the sale to agree on a personal financial plan, so plans and investments can be implemented efficiently once proceeds are received

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