Starting a business demands a lot of time, effort, and resources, both financial and human resources. To kickstart your entrepreneurial journey, one of the most critical resources you need is capital. You can fund your business using equity financing or debt financing. While equity financing involves hiring investors who buy shares of your business, debt financing involves borrowing money from banks, investors, or any other entity to be repaid later. Although debt financing can be an affordable and efficient way of raising capital, it comes with risks. To reduce the risks associated with taking on debt, you must manage it well. In this blog, I will discuss some best practices to manage debt financing for startups to avoid default.

Keep Your Debt-To-Income Ratio Under Control 🎯

The debt-to-income ratio, or DTI, is a crucial financial metric that measures the amount of money you owe compared to your monthly income. To calculate your DTI, add up all your debt payments and divide them by your monthly income. For instance, suppose you owe $3,000 per month and your income is $5,000. In that case, your DTI would be 60%. Generally, lenders prefer a DTI of 36% or less, and a higher DTI can result in higher interest rates, stricter borrowing requirements, or even loan rejection. To avoid default, you must keep your DTI under control by reducing your debt’s overall cost and minimizing unnecessary expenses.

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Create and Follow a Realistic Budget 💵

Creating a realistic budget is critical for debt financing. It helps you track your expenses and ensure that you have enough funds to repay your debt on time. When creating a budget, start by listing all your fixed and variable expenses, such as rent, salaries, office expenses, and marketing costs. Then, allocate funds to each expense category based on priority. For example, rent should be the highest priority, followed by salaries and other expenses. Also, don’t forget to create a contingency fund to deal with unforeseen events such as market fluctuations or unexpected expenses. Once you have created your budget, stick to it. A realistic budget that you can stick to is key to avoiding default and keeping your finances in order.

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Negotiate Favorable Loan Terms 🤝

When dealing with lenders and investors, negotiate favorable loan terms that suit your business’s needs and financial situation. The terms should include the interest rate, repayment period, collateral, and fees. Negotiating favorable loan terms can make a significant difference in your ability to pay off your debt without defaulting. Before accepting any loan, make sure to read the terms and conditions carefully and clarify any concerns you may have.

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Diversify Your Sources of Financing 🌱

Putting all your eggs in one basket can be dangerous, especially when it comes to financing your business. Relying on one source of financing leaves you vulnerable to that source’s risks and limitations. Therefore, consider diversifying your sources of financing. This way, you spread out your risk and create more options for raising capital. Some of the sources you can tap into include crowdfunding, grants, investors, or alternative financing options such as invoice financing.

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Hire a Financial Consultant 🤝

As a startup founder, you have to wear many hats, making it easy to overlook important financial details. Therefore, consider hiring a financial consultant to help you manage your finances and debt. A financial consultant can help you create a realistic budget, negotiate loan terms, and identify financial risks early before they become significant problems. They can also help you develop and implement debt-repayment strategies and provide valuable insights into your business’s cash flow.

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Conclusion

Managing debt financing is critical for startups to avoid default and ensure long-term success. By keeping your DTI under control, creating and following a realistic budget, negotiating favorable loan terms, diversifying your sources of financing, and hiring a financial consultant, you can improve your chances of success while lowering your risk of default. Remember that every business is unique, so it’s essential to customize your debt management strategies to suit your business’s needs and goals.

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