Debt Financing Options & Examples to Make Choosing Easy 

Debt financing is a term that refers to a person or company borrowing money (taking a debt) and making payments with interest to the lender. The interest rates can be fixed or variable, and depending on how “creditworthy” you are, you may be able to negotiate a cap or a fixed rate.   

Each form of debt financing can either be installment based, meaning you need to reapply once it is paid back, or revolving where it refills as you pay it back. And there are no shortage of options. 

The types of debt financing 

The types of debt financing include: 

• Commercial and small business loans 

• Credit cards 

• Lines of credit 

• Trade credit 

• Mezzanine financing 

• Invoice factoring 

• Merchant cash advances 

• Bonds 

A business credit card is a form of debt financing as it has interest payments when there is a balance due, but a business charge card is not debt financing because there is no interest as there is no balance, only late fees. 

Unlike equity financing where the company gives up part of the decision-making power and control, debt financing allows the company to retain ownership as they are paying money back instead of having investors. This is one of the main reasons debt financing is preferred over equity.   

Here’s a quick table to help you decide which option may be right for your company. After you’ll find more details on each option, so by the time you finish reading, you’ll be ready to finance your projects. Please note that some of the information is a general consensus and will depend on your financial history, time in business, business credit score, and each will vary by lender. 

	Revolving or Installment	Short or long term debt	Extra fees if paid early
Business loans	Installment	Long term	Sometimes
Credit cards	Revolving	Short term	No
Lines of credit	Revolving	Short term	No
Trade credit	Installment	Short term	No
Mezzanine financing	Installment	Long term	Yes
Invoice factoring	Installment	Short term	Yes
Merchant cash advances	Installment	Short term	No
Bonds	Installment	Long term	Yes

Commercial and small business loans 

Business loans can come from traditional lenders like banks and credit unions, alternative and online lenders, or even friends and family. In general, a business loan is considered commercial when it is over $1,000,000 for non SBA backed loans and $5,000,000 which is the maximum amount for SBA backed business loans with an exception where the SBA 504 can go up to $5,500,000.  Any business loan under $1,000,000 is likely considered a small business loan. 

Business loans are considered long-term financing (with short-term business loans being an exception) because the amount due will likely extend past one billing cycle or one year depending on the terms of the loan. It is an installment as the amount does not refill once the loan is paid back. 

Business credit cards 

Business credit cards are one of the easiest forms of debt financing a business can get approved for because the spending caps are normally lower for new companies, and the cap can be removed once there is trust with the issuer and a long enough financial history.   

Unlike bonds or trade credit, this is revolving credit meaning it refills each time you pay it back, and unlike business loans there is no interest payment required if you don’t carry a balance past the payment cycle. Because the balance will likely be paid off before the next accounting cycle begins, business credit cards are considered short term debt. 

Lines of credit 

A business line of credit is a short-term debt financing solution that lets you access cash when you need it, and only requires interest payments when you have a balance due past the billing cycle. This option comes with fees credit cards don’t have like withdrawal fees and inactivity fees, but both can have application and late repayment fees.   

Unlike a business loan, once you’re approved you get access to the funding and can spend it on just about anything, and it is revolving, so it refills once paid back where you’d have to apply for another business loan to get more financing. 

Trade credit 

Trade credit is a short-term type of debt financing where the borrower gets inventory, services, supplies, or raw materials in advance of payment and agrees to pay the lender back on a net 30-, 60-, 90-, or 120-day period. The actual time frame for the payment to occur will vary by deal and supplier, and may be heavily influenced by the relationship. 

Trade credit shows a lot of trust from the lender to the borrower as the lender takes a larger risk when the borrower defaults, and it is a good way to build their loyalty. Because there needs to be a level of trust, trade credit is harder to get approved for compared to a business credit card as the borrower will likely have to be a customer and prove their financial stability over a period of time to qualify.   

Mezzanine financing 

This is a mixture of debt and equity financing where investors provide capital to the borrower in exchange for high-interest rate payments. While the debt is owed, the investors will gain warrants or options (similar to partial ownership) and have the ability to convert debt into equity in the company. If the borrower does not make payments and goes into default, this will likely trigger the debt to equity and give the investors part ownership of the company.   

Mezzanine financing is riskier for investors because of subordinate to senior debt, meaning if there is a default, senior business loans and other types of senior debts may get paid off before the investors can try to recoup their losses. This may make it harder to find an investor if they don’t fully believe in your company or that they can turn it around if the situation arises where they would need to turn debt into equity shares.   

Invoice factoring 

If there are clients who don’t pay their bills, or you need fast financing and don’t mind risking customer relationships, invoice factoring lets you sell unpaid invoices to factoring companies at a portion of the value. From there, the factoring company will reach out to your customers and collect the debts directly. 

The factoring company may not be as polite or respect the relationship like you will, and that could sour the customer’s opinion of your business. It is always a best practice to let the customer know that you’re using invoice factoring if you value their business. 

Merchant cash advances 

When you need cash fast and you know your sales cycles, dedicated MCA lending companies may provide you with a merchant cash advance. You are provided with a lump sum of money that you can use for whatever purpose you agreed upon, and in return they collect a portion of each future sale until the debt is repaid. This is different from a business loan in that the repayment is tied to a portion of future sales rather than fixed installment payments. 

Bonds 

Similar to stocks, a company will issue bonds where people and companies can buy them at a fixed cost and collect payments with interest for a larger amount over a specific period of time.  The interest payments are called coupons and when the bond has had its last payment cycle, it will have reached “maturity” meaning the debt with interest is paid in full. 

While issuing bonds may sound good, the person or companies buying them must have faith and trust in your business in order to purchase. This makes it difficult for small companies and lesser-known ones to use this form of debt financing. Publicly issued bonds typically require SEC registration, which adds legal hurdles and costs. 

Debt financing is the perfect alternative to equity financing for business owners that want to keep control of their company’s decision making and to keep ownership of the business. Unlike equity financing, interest payments will need to be made, and debt is a legal obligation. If you’re looking for debt financing, click here and let us match you with a solution to meet your needs. 

SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.