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Debt Finance
Debt finance refers to the process by which a company raises capital by borrowing money that must be repaid over time, usually with interest. In debt finance, the company agrees to take on a financial obligation and repays the borrowed funds according to a set schedule. This contrasts with equity finance, where funds are raised by issuing shares in exchange for ownership stakes in the company.
Key Aspects of Debt Finance:
- Types of Debt Financing
- Loans: A business borrows a fixed amount of money from a bank or financial institution, which it repays with interest over a specified period. This could include:
- Term Loans: Borrowed for a set period (e.g., 1-10 years) with fixed or variable interest rates.
- Revolving Credit: A line of credit that allows a business to borrow up to a certain limit and pay it back, after which the credit becomes available again.
- Bonds: When a company issues bonds, it borrows money from investors. These bonds are typically issued for long-term financing needs (e.g., 5, 10, or 30 years) and pay periodic interest to bondholders. At maturity, the company repays the face value of the bonds.
- Commercial Paper: Short-term unsecured debt issued by corporations to meet immediate financing needs. Commercial paper typically matures within 1 year.
- Convertible Debt: Debt that can be converted into equity (usually at the holder’s option or at certain milestones), typically used by startups or growth companies.
- Bank Overdrafts: A facility that allows a business to withdraw more money from its bank account than it has, usually up to an agreed limit.
- Key Features of Debt Finance
- Principal: The original amount borrowed by the company.
- Interest Rate: The cost of borrowing, expressed as a percentage of the principal. This can be fixed or variable.
- Repayment Schedule: The timeline for repaying the debt, which can range from short-term (a few months) to long-term (several years).
