What is Debt Financing?

Debt financing is the use of a loan or a bond issuance to obtain funding for a business. The reasons for debt financing include obtaining additional working capital, buying assets, and acquiring other entities. Short-term debt financing is more commonly used to obtain working capital, while long-term debt financing is used to acquire assets. When debt financing is obtained, the borrower incurs an obligation to pay back the funds. The other type of financing is equity financing, where the entity sells an ownership interest to investors.

Advantages of Debt Financing

There are multiple advantages to using debt financing. First, it sidesteps the need to sell shares to investors. This means that the current owners of a business will not see their ownership interests in a business watered down. Second, interest expenses are tax deductible, which lowers the after-tax cost of debt financing. Third, debt can be used to invest in activities that generate more income than the cost of the debt. This means that a business generates a net gain in its income by using debt financing.