As the name suggests, debt financing is borrowing money from some financial institutions, usually a bank, which you will have to repay after a certain period with interest. Entrepreneurs may borrow money for short term, which means for less than a year. Usually short-term loans are for financing working capital requirements, operational activities, filling the gaps in accounts receivables and inventory (Horne & Wachowicz, 2008). On the other hand, long-term loans, which are for more than one year, are usually the ones that entrepreneurs usually look for to finance their assets, capital, land, buildings, machinery and other costs of starting a business venture.
Clearly, debt financing has certain advantages. Firstly, the interest that is paid on these loans is tax deductible thus providing a tax advantage (Bygrave & Zacharakis, 2010). Secondly, as we will see that equity financing provides a part of ownership in the business to its financers, however, the same is not the case with debt financing. Lenders, unlike shareholders, do not get any ownership in the business and thus the entrepreneur retains the sole control of the business (Shim & Siegel, 2008). Thirdly, the entrepreneur usually will get many options with regard to the maturity time and the amount of interest payable per month or per year. Lastly, compared with equity financing, debt financing is less hassle and less time consuming, whereas it may take months for someone to appear on a stock exchange list and getting enough shareholders (Brigham & Ehrhardt, 2008).
However, the disadvantages of debt financing are significant as well. Firstly, unexpected changes in interest rates due to economic downturns, at times, create a disaster for borrowers (Horne & Wachowicz, 2008). Moreover, even if these economic downturns of macro environment events fail to alter the revenue and