Legal Definitions - debt financing

Debt financing is a method of raising capital where an entity, such as a business or government, obtains funds by borrowing money that must be repaid over a specified period, typically with interest. This creates a debt obligation for the borrower to the lender.

• Example 1: Small Business Expansion Loan

  A local coffee shop wants to open a second location in a neighboring town. To cover the costs of renovation, equipment, and initial inventory, the owner applies for and receives a $75,000 business loan from a commercial bank. The loan agreement stipulates that the coffee shop must repay the principal amount along with a set interest rate over seven years.

  This illustrates debt financing because the coffee shop is borrowing money from the bank, creating a financial obligation (debt) that must be repaid with interest. The bank is the lender, and the coffee shop is the borrower.

• Example 2: Corporate Bond Issuance

  A large pharmaceutical company needs $500 million to fund a new research and development project for a groundbreaking drug. Instead of issuing new shares of stock, the company decides to issue corporate bonds to institutional investors. These bonds promise to pay investors a fixed annual interest rate for 15 years, after which the original principal amount will be returned to the bondholders.

  This is an example of debt financing because the pharmaceutical company is borrowing a substantial sum from investors by issuing debt instruments (bonds). The company is obligated to make regular interest payments and repay the principal amount at the bonds' maturity, clearly establishing a debt relationship.

• Example 3: Government Infrastructure Project

  A state government plans to build a new highway system to improve transportation and stimulate economic growth. To finance this multi-billion dollar project, the state issues municipal bonds to the public. These bonds allow individuals and institutions to lend money to the state in exchange for periodic interest payments and the return of their principal investment at a future date.

  This demonstrates debt financing because the state government is borrowing funds from investors through the sale of municipal bonds. The state incurs a debt obligation to repay the bondholders with interest, using future tax revenues or other dedicated funds to fulfill this commitment.