The core of any business system lies in its capital and funding capacity. The requirement for both of them depends on the business circumstances and nature – it could be short term or long term.
Meeting such requirements is crucial, and it can be either done by bringing in equity or raising debts. Keeping here in mind is that no other business structures can raise funds and finance via equity. Although, OPC (one-person company) is an exception. That is why raising funds and finance for startups with private ltd company registration in India becomes only possible via debt financing option.
Comprehending Debt Finance
When startups borrow funds from external sources, it is known as debt financing. And whenever startups borrow money from such sources at specified interest, it is known as finance through debts. It could be from banks, financial institutions, debentures, so on and so forth. It makes it easier for startups to raise funds and finances for their business.
Sources of Debt Finances for The Startups
One company can get/borrow a loan from other company/companies based on their financial needs. To do so, it has to comply with required companies act provisions.
In such a situation, any person (legal or otherwise) can purchase all companies’ receivables by paying an amount against it as a commission. The person making and performing such a transaction will be known as a factor in which the company obtains some portion of anticipated receivables beforehand.
On the verge of the due date’s arrival, the factor has to collect the receivables on behalf of the company. The entity will not be liable for any bad debts, and this type of borrowing method is usually used to meet the short-term requirements.
Advances and Loans
It is one of the predominant and favored ways for any startup to raise debts these days. Generally, long-term business requirements are served through loans, and loans are for the business’s long-term requirements. One can obtain a loan from a bank or financial institution with or without collateral security as per the bank and financial institutions’ terms and conditions, respectively. Nowadays, banks and financial institutions have eased the process of getting loans for startups, along with introducing schemes and plans. Short-term requirements can be served through advances. It could be in the form of a credit facility or overdraft from the banks. It is very crucial for the necessity of working capital.
Trade credit contains the purchase of goods and raw materials at credit and payable later. It is a very run-of-the-mill and preferable mode for startups. It serves the need for regular capital requirements. It is perceived as cheap and less expensive than a loan from a bank. It does not demand any collateral securities for credit. Entities and firms with high goodwill will easily obtain credit in the market.
Only companies registered as private limited companies are allowed to issue debentures to raise the money. Registering a company as a private limited company is simple in India, which falls under the Ministry of corporate and can be incorporated under the companies act, 2013. Private limited companies can get funds easily from the market in the form of Employees Stock Options (ESOP), private equity so on and so forth. Debentures can be issued at a fixed rate and a fixed period. Debenture holders are the company’s creditors and they do not possess any voting right in the company.
Through entering into a hire-purchase agreement, goods can be bought in installments. However, it is distinct from buying goods in installments. Only capital goods are allowed to be purchased under hire-purchasing. Here, proprietary goods transfer only when the seller gets the full payment. But the buyer will have a right to use it. If the buyer is not capable of paying the amount under any circumstances, then the seller can retake the goods.
The Cost Attached to Debt Financing
In debt financing, the commission or interest paid against the loan is deemed the debt cost. One should calculate the cost before taking debts.
– One should analyze and compare the rate of return on the capital. If the return rate is less than the cost of debt, then such a project cannot be profitable and reliable for the business.
– One should also check out the debt-to-equity ratio. It is advisable to have a low debt to equity ratio.
– One should also carefully calculate the risk involved in debts.
Debt financing is one of the great financing sources, as it could serve both short-term and long-term requirements. It is very advantageous because, in debt financing, you do not have to share the ownership with anyone. Thus, the control of the business stays with the promoters without any encroachment from outside.