The financing is subdivided depending on the legal position of the investor in debt financing on the one hand and self-financing on the other hand. As a hybrid between these two types of funding, the mezzanine financing is to be considered.
The term debt financing defines the supply (procurement) of capital in the form of external financial resources. The capital provided is called debt capital. Investors providing debt capital are called lenders. Debt financing thus forms the counterpart to self-financing, which raises equity capital.
Characteristics of debt financing
A key feature of debt financing is that lenders only make their capital available to the borrower for a limited period of time, ie for a certain term. After the end of this term, they will receive back their invested capital in the amount of the nominal amount. The remuneration for the leasing of capital is offset by a fixed or variable interest, which is considered to be independent of income. The borrower thus has the fixed obligation to pay principal and interest.
Unlike equity investors, lenders take a classic creditor position. It therefore does not assume any liability in the event of insolvency of the borrower. Unlike lenders, lenders do not acquire ownership or profit-sharing rights as creditors, but are entitled to non-performance-related remuneration (repayment and interest). Normally, the granting of capital itself does not give rise to any rights of participation or approval. However, they may be agreed separately in individual cases, especially in the provision of outside capital for companies.
Depending on their creditworthiness and lending volume, lenders are required by the borrower to provide collateral in the form of mortgages, collateral assignments or guarantees in the context of debt financing. Debt capital is given priority over equity. In the event of bankruptcy of the borrower, the lenders are initially satisfied.
From the viewpoint of the borrower, the interest to be paid in the course of debt financing represents company expenses and reduces the taxable profit, which means that they can be deducted from income tax or corporation tax.
As debt financing increases, so too does the risk of over-indebtedness, which manifests itself in a surplus of debt to assets. There is a risk that repayments and interest payments can no longer be afforded and insolvent.
Maturity and types of debt financing
Depending on the maturity of the capital resources provided, a distinction can be made between short-term, medium-term and long-term debt financing. Short-term debt financing is called a time horizon of up to one year. In the medium term, terms of between one and four to five years apply. Debt financing with longer maturities than four to five years is long-term.
The most important form of debt financing is debt financing, which covers all types of loans. Short-term to medium-term debt financing includes current account overdraft (overdraft facility), discount loan (interchange loan), Lombard loan, but also customer prepayment (customer credit), supplier credit and factoring.
In the medium term, traditional consumer loans are usually for the purchase of consumer goods. The most popular variant of long-term debt financing is represented by the traditional loans, which are usually granted by credit institutions. These include real estate, housing and home savings loans to consumers, but also investment loans to companies.
However, not only banks and savings banks are eligible as lenders. Loans can also be granted by companies or private individuals. The second group is the so-called personal loan. Long-term debt financing also includes bonds, bonds, warrant bonds, convertible bonds and participating bonds. Long-term debt financing deals with leasing and franchising, both of which are not credits substitutes.