Last Updated on Oct 20, 2022 by Anjali Chourasiya
If you follow business and economic news, you would have come across multiple reports of companies raising ‘debt.’
But what does ‘raising debt’ mean? And why is it an essential ingredient for enterprises?
For a layman, the term ‘debt’ refers to a sum of money that one party borrows from another party and owes it to them.
The phrase ‘raising debt’ is generally used when enterprises receive securities, often money, at a certain rate of interest, to fund their operations, supply chain, or simply ensure that the business is run without facing a scarcity of funds.
Debt is the amount raised from investors, banks, NBFCs, financial institutions, etc. The process of a company raising debt to streamline its business operations can be understood as debt financing.
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Why is debt financing important?
Debt financing can be both secured and unsecured, where collateral may or may not be important. Although credit of any kind – debts or loans – has been viewed negatively for decades, debt can act as an important turning point that can springboard a company on the path of growth and progress. Debt finance may have a traditionally negative connotation attached to it, but healthy amounts of debt to support a company’s growth is ever important.
Here are the top 5 benefits that enterprises enjoy when they say yes to debt financing when in need.
- Retain ownership
Raising debt is a great alternative to giving away your company’s equity to investors in exchange for funds.
Raising debt is an affordable way of mobilising funds for business growth vis-à-vis unorganised forms of debt or equity.
All corporate finance professionals agree that the cost of equity is always higher than the cost of debt, and enterprises need to also realise this. Thus, they can take advantage of low interest rates and raise debt to promote their business’ growth.
- Multiple options
Enterprises have multiple options to mobilise debt; there are multiple lenders (Eg: banks, NBFCs and small finance banks among others) and multiple debt products to suit the requirement of enterprises (Eg: short term loans, long term projects loans etc.)
- Financial discipline
Raising debt also helps invoke a sense of financial discipline and responsibility in enterprises. It promoted judicial use of the funds raised in addition to the responsibility of working towards larger goals to repay the debt.
Challenges while raising the debt
Though raising debt sounds like a great option for acquiring funds at a reasonable cost, it is not as easy as one may assume. Enterprises often face rejections despite having killer products or services, great financial numbers in the past, a good credit score, and/or a highly convincing business plan.
Here is a look at some of the top challenges enterprises may face while raising debt:
- Lack of clarity
Many enterprises do not have a business plan handy when they begin to raise debt. The downside to this is not being able to understand how much money is needed for business expansion, paying vendors, stockpiling on raw materials, etc. Many think that raising as much debt as you can is the way to go- unfortunately, this can prove to be detrimental. Not having clarity on why an enterprise needs to raise debt and how much can curb growth.
- Choice of the right product
Not choosing the right kind of debt can become a liability for the enterprise instead of easing the financial burden. Many enterprises may end up raising the wrong kind of debt, which can harm their future prospects. For example, any debt raised, which can potentially decline the net value of your enterprise instead of adding value is the wrong kind of debt. Instead of raising debt just because of attractive interest rates is also a wrong kind of debt that you can avoid.
Educate yourself about the right product that best fits your needs. And because knowledge is power, it is critical to boosting your understanding about the investment market by using the right resource that educates and informs investors. Tickertape is a wholesome culmination of technology and information that spearheads this mission of making personal finance and investor education widely available in the country.
- Ability to support evaluation
Countless enterprises are unaware about the regulatory compliances put in place to safeguard their interests. Not being aware of regulations and associated compliance guidelines while raising debt can lead to enterprises being caught in situations that may not have favourable outcomes.
- Choice of the right partners
There are multiple debt partners for enterprises to choose from when they mull raising debt. One of the most often used options is asking friends and family for funds. However, there are considerable risks to bringing in kin and friends into the picture. This way you are not only risking their financial future, you may also end up straining your relationship with them if things do not go as planned.
Choosing the right partner can have a significant impact on how the enterprise raises debt, what the turnaround time for disbursal is, and how successfully they access multiple options to choose from.
One of the most efficient ways for enterprises to source and quickly secure debt financing is through leveraging information and technology. Yubi is India’s largest corporate debt platform, facilitating easy financial access for enterprises.
Tips on raising debt efficiently by businesses
Now that you know the kind of challenges enterprises may face while raising debt, here is a checklist you can keep handy to raise debt efficiently:
- Have a scalable business plan
This is done in the preparatory phase when you are planning to raise debt. The business plan outlines how your company plans to achieve its short-term, long-term, and mid-term goals. A business plan will help your enterprise and the investors plan for organic/inorganic growth, mergers & acquisitions, and then underlining the financial requirement to do the same.
This will help both the enterprise and the investor understand how much money the company needs, and how they plan on returning it back.
- Understand your requirement
Before venturing out to scour for deals, enterprises need to understand whether they want a long-term or a short-term loan. Short-term loans will require repaying the loan in under one year and long-term loans range upwards of one year.
Additionally, there are multiple types of loans (asset-backed loans, corporate debt, term loans, vendor invoice financing, or simply a line of credit). Having clarity on the type of credit your business wants to pursue will help attract the best deals.
- Survey the market for the right partner
Undertake a market survey and explore the debt finance market. Understand what venture capitalists (VC), institutional investors, firms, and financial institutions have been asking for. Going to a bank with a credit score of 400 when their policy demands for 550+ can do more harm than good.
- Understand all associated obligations
When liasoning with an investor to raise debt, ensure that your enterprise has crystal clear clarity on the compliance, fees, and repayment guidelines. Calculate the cost of capital your enterprise will incur. Different lenders charge varying fees when they offer debt to enterprises. Some common charges include processing fees, foreclosure charges, unused fees, interest rates, amortisations, etc.
Understand whether the interest rate offered to you is flat or reducing to be able to make the best-informed decision. Ensure that there are no blurry lines when it comes to repayment timelines.
Debt financing has been helping businesses grow exponentially, giving them easy access to working capital, helping finance supply chains, and fund business operations. However, raising debt efficiently is the key to overcoming common challenges enterprises face while raising debt.
- How To Raise Debt Efficiently for Your Business - Jul 21, 2022