09: Finance
Debt Financing
Debt financing is one of the most common ways that CPG brands can access the capital they need to grow. Whether you’re scaling production, funding a new product launch, or managing cash flow during slow seasons, borrowing money can provide a flexible solution. However, like any financial tool, debt financing must be handled carefully to avoid straining your business.
In this chapter, we’ll explore what debt financing is, when it’s appropriate for your CPG brand, and how to navigate the various options available to you.
What Is Debt Financing?
At its core, debt financing involves borrowing money from a lender (such as a bank, credit union, or private lender) and agreeing to repay the loan with interest over time. Unlike equity financing, where you give up a portion of your ownership in exchange for funds, debt financing allows you to retain full control of your business—but comes with the obligation of repayment.
When Should You Consider Debt Financing?
Debt financing can be a great option in a number of scenarios:
- Working Capital Needs: If you’re facing cash flow gaps due to the timing of retailer payments or seasonal sales dips, a short-term loan can provide the cash needed to keep your operations running smoothly.
- Expansion: Growing your business, whether it’s expanding production capacity or entering new markets, often requires significant upfront investment. Debt financing can provide the funds needed to scale your business without giving away ownership.
- Inventory and Equipment Purchases: For many CPG companies, keeping enough inventory on hand or upgrading equipment to meet demand is critical. Loans can help you cover these costs without dipping into your operational cash.
- Bridge Financing: Sometimes you need a loan to “bridge” the gap between large expenses and future revenue. For example, if you land a big purchase order but need capital to fulfill it, a bridge loan can help you meet the order before your customer pays you.
That said, debt financing isn’t a one-size-fits-all solution. If your business is still in the early stages, working to establish product-market fit, or if you’re uncertain about consistent revenue, you may want to explore other funding options before taking on debt.
Types of Debt Financing
There are several types of debt financing available to CPG brands, each with its own advantages and risks. Here are some of the most common options:
1. Term Loans
A term loan is a lump sum of money that you borrow upfront and repay over a set period, typically with fixed monthly payments. These are ideal for larger investments, such as purchasing equipment or funding expansion.
Pros: Predictable payments, long repayment periods (3–7 years), large sums available.
Cons: You need strong credit, may require collateral, and interest rates can vary based on the lender.
2. Lines of Credit
A line of credit functions like a credit card. You have access to a set amount of funds that you can draw from as needed. You’re only charged interest on the amount you actually use.
Pros: Flexible access to funds, ideal for covering short-term needs like working capital.
Cons: Can lead to overspending if not managed properly, and interest rates may be higher than term loans.
3. Equipment Financing
If you’re looking to finance equipment purchases, equipment loans use the equipment itself as collateral. This means you can typically get better interest rates and terms than with unsecured loans.
Pros: Lower interest rates, equipment acts as collateral.
Cons: You risk losing the equipment if you default on the loan.
4. Invoice Financing
With invoice financing (also known as factoring), you borrow against your unpaid invoices. The lender gives you an advance on the money you’re owed, typically charging a fee or interest until the invoice is paid by your customer.
Pros: Quick access to cash, based on future revenue.
Cons: Fees can add up, reducing your overall profit margin.
5. SBA Loans
The Small Business Administration (SBA) offers loans that are backed by the government, making them more accessible to small businesses. While the application process can be rigorous, SBA loans often come with favorable terms and lower interest rates.
Pros: Low interest rates, longer repayment terms, government-backed.
Cons: Lengthy application process, can require significant paperwork and strong financials.
Pros and Cons of Debt Financing
Before taking on debt, it’s crucial to weigh the pros and cons:
Pros:
You maintain ownership and control over your business.
Debt can be used to fuel growth, allowing you to take advantage of opportunities without waiting for cash flow.
Interest payments on business loans are often tax-deductible.
Cons:
Loan repayments can strain your cash flow, especially if sales fluctuate.
You risk damaging your credit or losing assets if you default on your loan.
Interest costs can add up over time, increasing the total cost of the loan.
Steps to Secure Debt Financing
- Get Your Financials in Order: Before applying for a loan, make sure your financial documents are organized. Lenders will want to see your Profit and Loss statement, Balance Sheet, and Cash Flow Statement. Be prepared to explain how you’ll use the funds and how you’ll repay the loan.
- Shop Around: Not all lenders offer the same rates and terms. Compare options from traditional banks, credit unions, and online lenders to find the best fit for your business.
- Consider Collateral: Some loans require collateral (assets like equipment, inventory, or real estate) to secure the loan. Be sure you’re comfortable with the risk of putting up collateral.
- Know Your Numbers: Have a solid business plan and financial projections to show lenders you can generate enough revenue to repay the loan. Be realistic about your sales forecasts and cash flow projections.
Final Thoughts: Is Debt Financing Right for Your CPG Brand?
Debt financing can be a powerful tool for CPG brands looking to grow, but it’s not without its risks. Make sure you have a clear plan for how you’ll use the money and how you’ll repay it before taking on any debt. If managed wisely, debt can help you scale your business faster and take advantage of new opportunities without giving up control.
Next up: Equity Financing—how to leverage investors to grow your business while balancing ownership and control.