Whether it’s opening a new location, stocking up on seasonal inventory or upgrading tech to stay competitive, every growing retail business hits a point where extra capital could make all the difference. But securing funding isn’t always easy, and choosing the right financing option can feel overwhelming.
Debt financing is one way to get the cash you need without giving up ownership of your business. It can provide the financial flexibility to fuel growth, but it also comes with obligations that could impact your bottom line. Like any financial decision, it comes with both opportunities and risks. Understanding the advantages and disadvantages of debt financing (and whether its benefits outweigh the drawbacks) can help you make the best decision for your business’ future.
- What is debt financing?
- Advantages of debt financing
- The disadvantages of debt financing
- Tax benefits of debt financing
- Alternatives to debt financing
- Debt vs. equity financing: Weighing your options
- Need funding for your business?
The guide to raising capital
In this guide, we'll share everything you need to know about getting funding to start or grow your business
What is debt financing?
Debt financing is when a business borrows money from an external source, like a lender or a bank, to be repaid at a future date. In return for a loan, creditors are then owed interest on the borrowed funds. Lenders typically require monthly payments, on both short- and long-term schedules.
Debt financing can also include peer-to-peer lending and government-subsidized loans. These loans are usually designed to help small businesses acquire capital with reduced risk—more on that below.
An example of what debt financing looks like
To get a better understanding of debt financing, let’s take a look at the following scenario.
Sarah’s pet store sells supplies, food, equipment and accessories. Business has been steady since she opened five years ago, but it’s really taken off in the last few months. Lately she’s been thinking about opening another location to expand her business, which would allow her to meet demand and reach more customers.
Sarah has strong cash flow and money saved up to make an investment in her new location, but she estimates she’ll need at least $60,000 to cover basic costs to get it up and running. She decides to go to her bank for a cash-secured business loan. It works out to a five-year, lump-sum loan of $50,000 with a 6.2% fixed interest rate.
Advantages of debt financing
You won’t give up business ownership
One major advantage of debt financing is that you retain full ownership of the business. When you take out a loan from a financial institution or alternative lender, you’re obligated to make the payments for the life of the loan, that’s it.
In contrast, if you give up equity in the form of stock in exchange for funding, you might find yourself making concessions to meet the requests of these outside parties.
There are tax deductions
One of the most attractive aspects of debt financing is the tax deduction on interest payments. Because interest paid on business loans is often tax-deductible, it can significantly reduce your taxable income, saving you money in the long run.
Pro tip: Always check with a tax professional or other financial planner to help answer specific questions about how debt affects your taxes!
Low interest rates are available
Credit cards, peer-to-peer lending, short-term loans and other debt financing options aren’t helpful if the interest rates are sky-high. In these instances, a Small Business Administration (SBA) loan is a great option for low-cost funds.
SBA loans offer the best deal with low rates and long terms, but if they’re out of reach, explore other options carefully. Watch out for hidden costs and complex payment structures, which can signal trouble; remember: transparency from your lender is key. SBA loans are particularly beneficial for businesses expanding to multiple locations, often requiring at least a year of operation and strong credit for the best rates.
You’ll establish and build business credit
According to Investopedia, one of the primary reasons why small businesses fail is a lack of funding or working capital. Stellar business credit is crucial if you’re seeking low-cost, long-term debt funding. So, having the ability to build your business credit is a major and crucial advantage to taking out a loan. When you build your small business’ credit, you reduce the need to rely on your personal credit or other high-cost business financing options.
Building a solid financial reputation can also lead to better deals with suppliers. And for businesses aiming to grow, especially by opening new locations, a strong track record will give lenders the confidence they need to approve your loan applications.
Debt can fuel growth
Long-term debt can provide the strategic resources your business needs to take the next step. A well-managed, low-interest loan can supply the working capital for sustained growth, enabling you to build your team, amplify your marketing efforts and gain a significant advantage in the market. This approach transforms your business from a stable operation into a more dynamic, expanding enterprise.
Debt financing can save a small business big money
Often, small business owners rely on expensive debt, like credit cards or lines of credit to get their business off the ground. This type of debt cuts into cash flow and can hinder day-to-day operations. A big advantage of debt financing is the ability to pay off high-cost debt, reducing monthly payments by hundreds or even thousands of dollars. Reducing your cost of capital boosts business cash flow.
Bigger businesses can benefit from debt refinancing
Debt refinancing is useful for businesses that already have debt, and want to renegotiate the terms to make them more favorable. Essentially, you take out a new loan to repay your existing debt, allowing you to update your lending agreement to something that works better for you. You can get a lower interest rate this way and even improve your credit score.
Let’s take a look at our friend Sarah’s scenario again to get a better idea of debt refinancing. Let’s say when she first started her business, she borrowed $80,000 from her bank, plus 7.4% interest. She’s been paying her original debt monthly ever since, but it hasn’t been paid in full yet. Keeping the fact that she’s opening a new business location in mind, she decides to refinance her debt instead of taking out a brand-new loan. This way, she can pay the rest of her original debt and negotiate a lower interest rate and better terms while she’s at it.
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The disadvantages of debt financing
You must repay the lender (even if your business goes bust)
The rules are clear when you work with a lender: you have to pay the piper. That means, even if your business goes under, you still have to make payments. Since most lenders require you to guarantee the loan, your assets could be sold to satisfy your debt.
Qualifying can be difficult
Eligibility requirements vary among lenders, but generally you need to have a strong credit history, meet a revenue threshold and be operational for a minimum number of years. Consider all your debt financing options to figure out what’s best for your business so you don’t have to waste time applying for capital that you may not meet the requirements for.
High rates
Unfortunately, predatory lenders roam among us and the techniques they use to rope in unsuspecting small business owners are getting more and more sophisticated. It’s definitely not unique to debt financing, but it is something to be aware of. Instead of disclosing the true cost of a loan, some unscrupulous lenders will use methods other than the annual percentage rate (APR). For clarity and trust, lenders should be transparent in their practices and provide honest figures. You should receive clear information about the loan’s APR and total payments, which you can then easily compare to the original balance.
Tax benefits of debt financing
One of the key financial advantages of debt financing is its potential tax benefits. In most cases, the interest paid on business loans is tax-deductible, which can significantly reduce your taxable income. For retailers, where cash flow management is critical—especially during seasonal highs and lows—this deduction can help offset borrowing costs and improve overall profitability. By lowering your tax liability, debt financing becomes a more cost-effective way to access the capital needed for expansion, whether that means securing prime retail space, increasing inventory ahead of the holiday rush or investing in new technology to streamline operations.
Taking advantage of tax-deductible interest can also free up more working capital for other essential expenses, like staffing, marketing campaigns or customer experience improvements. When used strategically, these tax benefits not only help retailers manage their debt more effectively but also create opportunities for sustained growth and long-term financial health.
Alternatives to debt financing
Ultimately, your business’s specific needs will determine the type of financing that you need. It’s helpful to be aware of the various options at your disposal so you can make an informed decision.
Merchant cash advances
A merchant cash advance (MCA) involves a business receiving up-front working capital in exchange for a percentage of future sales. The “purchase amount” includes the cash advance and a flat fee and isn’t subject to shifting interest rates.
With a merchant cash advance, you get your money upfront. Then, you repay it by giving the lender a portion of your daily sales, plus a fixed fee. Businesses that need cash quickly often use this option. However, that fixed fee can sometimes be higher than the interest you’d pay on a regular loan, which makes some businesses hesitant.
Let’s break down the differences between debt financing and merchant cash advances:
| Criteria | Debt financing | Merchant cash advances |
| Interest rates | Fixed or variable interest rates; typically lower than MCAs | Flat fee, can be higher than traditional loans |
| Repayment terms | Fixed repayment schedule, regular installments | Remitted through daily or weekly sales |
| Collateral | Secured (e.g., assets, property) or unsecured, depending on the loan type | Remittance tied to daily sales; no specific collateral required |
| Ease of application | More extensive application process, credit checks, and financial documentation required | Quick and simple application process; less emphasis on credit history |
| Impact on credit | Can impact credit score if not repaid on time or if financial difficulties arise | Repayments tied to sales, so credit isn’t impacted |
For eligible Lightspeed merchants, accessing a merchant cash advance is even simpler with Lightspeed Capital. By leveraging your sales history, we offer tailored cash advances without the hassle of traditional loan applications. Use the funds to stock up on inventory, invest in new equipment, or cover unexpected expenses—whatever your business needs. Plus, with no fixed repayment schedule, payments automatically adjust based on daily sales, making it a flexible and stress-free way to access capital.
Equity financing
With equity financing, businesses raise capital by selling ownership shares, otherwise known as equity, to investors. In exchange, investors receive ownership stakes in the company, either as common or preferred stock.
Equity financing differs from debt financing because businesses don’t have to repay borrowed funds with interest. Instead, they become partial owners of the business and are involved in both its profits and losses. While there are advantages to this strategy, this can be a deterrent for businesses who want to maintain full ownership.
Government grants
A government business grant is money that’s provided to a business by donors including federal and state governments. The money is provided for a specific purpose, such as for companies operated by underrepresented communities or that are carrying out research.
Because government grants don’t have to be paid back, they are typically quite difficult to secure. Your business has to fit a specific set of requirements to apply, and you’ll need a strong business plan and justification for your application.
Debt vs. equity financing: Weighing your options
When businesses need funding, they typically choose between debt financing and equity financing—each with its own trade-offs. Consult the table below for a handy breakdown of the differences between debt and equity financing:
| Criteria | Debt financing | Equity financing |
| Nature of financing | Borrowed funds that must be repaid with interest | Capital raised by selling ownership stakes |
| Ownership | No dilution of ownership; lender has no equity stake | Involves selling ownership shares, leading to dilution of ownership |
| Repayment obligation | Fixed repayment schedule with interest payments | No fixed repayment obligation; returns tied to business performance |
| Risk and reward sharing | Lender bears no risk in business success or failure | Investors share in the risks and rewards of the business |
| Interest rates | Fixed or variable interest rates | No interest payments; returns based on equity participation |
| Collateral requirement | May require collateral (secured loans) | Generally, no specific collateral requirement |
| Source of funding | Provided by financial institutions, lenders | Raised from investors, including venture capitalists, angel investors, or the public through IPOs |
| Decision-making control | Borrower retains control over business decisions | Shareholders may have voting rights and influence on decisions |
| Purpose of funding | Used for various business needs, with a focus on repayment | Typically used for high-growth initiatives, as investors seek returns through appreciation of company value |
| Application process | More extensive application, credit checks, financial documentation | Less emphasis on credit history; may involve pitch presentations to investors |
Need funding for your business?
If you’ve decided that extra funds can take your business to the next level, it’s important to examine the advantages of debt financing. Remember that all debt is not created equal. So, strive to maintain strong credit scores so that you can get the lowest APR and the longest terms—ultimately, ensuring the health and longevity of your business.
Are you a Lightspeed (and Lightspeed Payments) customer that’s in need of funding? If so, visit our website to learn more about Lightspeed Capital.
If you want to get started with Lightspeed, talk to an expert today about our point-of-sale offering.
Debt financing FAQs
1. What does debt financing involve?
Debt financing involves borrowing money to fund business activities. Businesses receive a loan and agree to repay the borrowed amount with interest over a specified period.
2. What are the pros and cons of debt financing?
Pros of debt financing include immediate access to capital, interest payments may be tax-deductible, no dilution of ownership. Cons of debt financing include the obligation to repay with interest, potential for financial strain, risk of default.
3. What is the most common source of debt financing?
Banks and financial institutions are the most common sources of debt financing for businesses.
4. Why is debt financing considered a better option over equity?
Debt financing allows businesses to retain ownership and control. Interest payments are fixed, providing predictability in financial obligations.
5. Why do companies use debt instead of cash?
Companies may use debt instead of cash to leverage their resources, preserve cash for operational needs, and take advantage of investment opportunities without immediate out-of-pocket expenses.
Editor’s note: Nothing in this blog post should be construed as advice of any kind. Any legal, financial or tax-related content is provided for informational purposes only and is not a substitute for obtaining advice from a qualified legal or accounting professional. Where available, we’ve included primary sources. While we work hard to publish accurate content, we cannot be held responsible for any actions or omissions based on that content. Lightspeed does not undertake to complete further verifications or keep this blog post updated over time.
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