The advantages of debt financing are numerous. First, the lender has no control over your business. Once you pay the loan back, your relationship with the financier ends. Next, the interest you pay is tax deductible. Finally, it is easy to forecast expenses because loan payments do not fluctuate.
Investments in debt securities typically involve less risk than equity investments. However, they also typically offer a correspondingly lower potential return on investment. These investments fluctuate less than the stock market between highs and lows, thus making them less volatile than common stocks. Debt investments are not centrally traded but are traded over-the-counter, or OTC. Bonds are the leading form of debt investments, although mortgages are also included in this asset category. Mortgage investments are secured by the underlying real estate as collateral. Historical data show that both bond and mortgage markets have been exposed to far fewer significant changes in price than stocks. Also, in the event a company is liquidated, bondholders are the first to be paid.
Purchasing a home, a car or using a credit card are all forms of debt financing. You are taking a loan from a person or business and making a pledge to pay it back with interest. Debt financing for your business works in a similar way. As a business owner, you can apply for a business loan from a bank or receive a personal loan from friends, family or other lenders, all of which you must pay back. Even if family members lend you money for your business, they must charge the minimum IRS interest rate in order to avoid the gift tax.