If well planned and chosen wisely, business finance can kick start start-ups, businesses seeking growth, or looking to refinance, as well as businesses experiencing changing market conditions or wanting to take advantage of opportunities.
Companies may also need to seek business finance from various sources at different times, depending on each circumstance.
Searching for business finance can be time-consuming and complex. It isn’t a case of seeing what business finance you qualify for, then finding the least expensive source.
Before embarking on securing business finance, the team at Penguin Management recommend you –
- Research the vast business finance options that are available (yes, there are hundreds!). A thorough understanding of these options can help you make wise choices for your business.
- Educate yourself – business finance is not easy to navigate. Should you choose the business loan with a lower interest rate but rigid payment terms or the loan that has a higher interest rate but flexible payment terms? It’s important to not only consider where your business is at today but its growth trajectory and the impact of the business finance on the business, now and in the future. Arming yourself with a detailed knowledge of financial strategies is recommended to make a wise choice.
- Look at costs – a focus on costs is key to calculate the true cost of the finance. Not only interest rates, but general loan charges, discharge fees, stamp duties as well as financial advisor fees and charges. Ask your business lender for the cost breakdown in dollars, not just percentages.
Benefits of business financing
Business finance plays an important role in ensuring you have ample funds available for the company to operate smoothly and take advantage of opportunities. However, it is vital that it is managed well – the money is being spent wisely and used for shrewd long-term investments.
Business finance can help –
- Start-ups – a new company needs funds to get it off the ground, not just for general business expenses but also to hire staff, marketing and sales, as well as investing in research and development.
- Businesses seeking growth – to expand your business into new markets here or internationally, move to bigger premises, develop new products or services, or hire new talent, funding may be required to take it to the next stage.
- A need to refinance – debt restructuring could help your business save money, improve cashflow or consolidate your debt to open new opportunities for your business.
- An unexpected change or opportunity in business conditions – business finance can cover your business during short-term market downfalls or open your business to take advantage of favourable market conditions.
If your business has decided it needs to source funds for any of these reasons, business finance is different from personal finance, so you need to know about the different types of financing and the effects this financing can have on your business.
What are the types of business finance?
There are many business financing options available but the decision basically comes down to two different types of finance:
Debt finance is where the money is borrowed from a lender for the business. For example, loans from financial institutions, invoice finance, your suppliers, or finance retailers.
Debt finance loans can be long or short term, secured against assets (either business assets or director assets), require specified regular repayments over a set period of time, and the interest is tax-deductible.
Unsecured business finance such as credit cards and business credit lines can be used to cover business expenses without the need for collateral. However, these options tend to incur higher interest rates than secured business loans. For this reason, it is recommended you only use these products in the short-term and pay off balances as soon as possible. Secured business finance generally, has lower interest rates however, they tend to be harder to obtain and require extensive documentation.
Equity finance is where the money is provided to the business, in exchange for owning a part of the business. The investor becomes a shareholder. The money does not need to be repaid by the business, but the investor can gain returns from the profit made by the business.
With equity finance, the money is not repaid, and no interest is accrued, however, the investor will have a share in the business decisions. Investors can be in the form of venture capitalists, family and friends, self-funded or the stock market.
What are the best finance options for my business?
While a debt loan can have long-term financial responsibilities, the business is yours free to own and remains under your control. Equity finance gives your business a cash injection, but you will have to divide the profits.
How you decide to finance will impact how your business will operate from that point forward.
Here are a few things when considering the type of business finance that is best for your business –
- Write a sound business plan, outlining what and why you need the money and how it will improve the business – cash flow, increase market share, profits, grow product line, improve efficiency in production.
- Define how much money you will need – this will help you determine the kind of business finance you will need.
- How will the business repay the loan (in the case of debt finance)? Taking into consideration cash flow, the cost of interest and other loan costs as well.
- Over what period will your business realistically be able to repay the loan?
Where can I get finance for my business?
Debt finance can be sourced from –
- Financial institutions – this includes banks, credit unions and building societies. These institutions have multiple options on offer depending on your needs, from overdrafts, lines of credit or credit cards, equipment leasing and hire purchase.
- Finance companies – most finance companies offer finance products via a retailer. Financial companies must be registered with the Australian Securities and Investments Commission (ASIC).
- Finance brokers – offer a panel of lenders across a myriad of products and services to help you find the most suitable business finance for your needs.
- Retailers – store credit through a finance company to purchase goods for your business such as computer equipment. These store cards can attract high-interest rates, however, some retailers offer an interest-free period.
- Suppliers – the suppliers who provide your business with product and services can offer favourable trade credit, allowing your business to delay payment.
- Factor companies – also referred to as debtors finance. Factoring is when a business sells its accounts receivable (invoices) to a third party (called a factor) so that the business can receive cash without waiting the 30 or 60 days for the customer payment.
Customers pay their invoice directly to the factoring company when the invoice is due. The cost for providing this service can vary greatly between companies so it is important to research these costs before entering into any agreement.
- Invoice finance – essentially the same as factoring, however invoices are paid to your business and customers are not aware of your arrangements with the financier.
- Peer-to-peer lenders – this service matches people who have money to invest with businesses looking for a loan. Loans may need to be repaid within a certain time period and interest rates may vary according to the level of risk.
- Family or friends – may offer money to your business as a loan. To avoid misunderstanding down the track, it is important to have a formal written agreement specifying the terms of the loan, repayment requirements and terms of interest. Seek legal advice to draw up the loan agreement.
- Microloans – The introduction of fintech business lenders, small businesses can now access microloans. This new breed of alternative lenders uses innovative technology to provide unsecured loans with quick response loan applications and cheaper lending costs for business.
The main sources of equity finance are:
- Personal finances – self-funding of your business from personal savings or the sale of personal assets.
- Venture capitalists – professional investors that invest for equity, large funds into businesses with potential for high growth and profit.
- Family or friends – provide funds in return for a share in your business or as a partnership. This option should be carefully considered as it comes with an element of danger as a breakdown in business relationships may affect your personal relationships.
- Private investors – also known as ‘business angels’, are generally wealthy individuals who invest large sums of money in a business in return for equity and a share of the profits.
- Crowdfunding – sourcing capital through the collective efforts of a large pool of individuals. The capital is mostly raised online via social media or crowdfunding platforms. Investors provide large sums of money in exchange for equity in the business or smaller amounts in return for a first-run product or other rewards.
- Crowd-sourced equity funding – a way for start-ups and small businesses to raise finance from the public. They usually rely on raising small amounts from many investors. Each investor can invest up to $10,000 a year in business, receiving shares in exchange.
- Government – most government assistance for small business is in the form of free or low-cost advisory services, information or guidance. However, you may be eligible for a grant in certain circumstances, such as business expansion, research and development, innovation or exporting. Check out our article on Government grants to see if there is one suitable for your business.
Business finance is complicated with a myriad of options available. Consider the short and long-term needs of your business carefully before choosing one option over another. If possible, seek the advice of your accountant or our accountants at Penguin Management are happy to assist to go through the best financing for your business. Click here to contact us or call 1300 319 870.
Maybe your business doesn’t need short-term business finance. Perhaps it needs to take better control of its cashflow? Here are some simple ways to improve your business’ cash flow.
A business budget can give a snapshot of its performance and help you identify possible future investments. Read our blog on Better Budgeting (How to have your best year yet) on why you need to create a budget.