Financing can be a good option for businesses seeking funding to support growth, or in some cases launch – its also usually tax-deductible which doesn’t hurt. The main downside to any kind of financing is that lenders charge interest, meaning you have to pay back more than was initially provided – depending on the interest rate the sum repaid may be far larger than the initial loan, particularly for unsecured or shot-term finance products..
Below you’ll find the key forms of debt financing available to businesses. Th the popular finance options listed and explained in detail below, we hope to make your journey to finding and securing finance a little easier.
1. Business Loans
Business loans typically allow you to borrow an agreed sum of money and pay it back over a certain period with interest. There are two major types of loans:
- Secured Business Loans – The borrower of the loan puts up some collateral such as a house, car, or shares against the value of the loan. If repayment fails, the asset can become forfeit to the loan provider.
- Unsecured Business Loans – The borrower of the loan doesn’t put up any collateral, the loan is given based on the borrower’s current situation.
Business loans are generally seen as a source of finance for the medium to long-term. Typically, loans are advantageous as there are many options available, both commercially and government-backed (like the startup loans scheme). You’re not selling equity in your business like with venture capital, and you can shop around for an affordable payment rate and plan. For companies in the UK, there are also some tax benefits on paying back a loan.
If you do take out a business loan, make sure the payment terms and timeline is realistic for your situation and gives you some room if things don’t quite go to plan. Loans remain the most popular option for businesses starting out and one of the most popular finance options for companies looking to expand.
If you are applying for a loan, the primary requisite is that your finances and accounts are up to date, and you have a clear plan to pay it back. Of course, depending on the loan provider, there can be many other prerequisites such as monthly revenue, credit rating, years trading, etc.
2. Business Overdrafts
A bank overdraft is an ideal source of finance for the short-term. An agreed overdraft lets businesses use their current account to make payments which exceed their available balance. In other words, the company owes the bank money when the balance goes below zero.
You can borrow anything up to an agreed limit, known as the facility. Companies can negotiate different amounts with the bank, depending on their need and credit history. Some banks charge an overdraft facility fee, in addition to the interest charged on the overdrawn credit. For a larger overdraft facility, banks may require companies to put up security in the form of tangible fixed assets, or a personal guarantee made by the company’s director.
Overdraft financing is useful when a business struggles with timely cash flow. Overdrafts are particularly helpful to cover short-term cash flow shortages from seasonal activities. Banks tend to review overdrafts on an annual basis.
Given the high-interest rates, overdrafts should not be a permanent source of finance. Banks can revoke an overdraft at any time and demand full repayment of the owed funds. For a more permanent solution, consider a bank loan.
3. Invoice Finance
Invoice financing allows companies to borrow money against the value of invoices due from customers. There are two primary forms of invoice finance, being invoice factoring and discounting. Typically you can receive up to 85% of the value straight away and the remaining amount (minus the finance charge) when the customer pays the invoice.
Invoice finance can be a great option if you have many corporate or SME customers who have long payment terms or tend to pay as late as possible. It’s a great finance option for plugging holes in cashflow. Your invoice is generally bought as debt in most cases; it’s common practise that if the invoice isn’t paid, you will be shielded from any debt owed.
Although this is an excellent option for finance, invoice financing is only available to companies with a strong track record of generating revenue and getting paid by customers. It’s designed to alleviate the problems that come from 30, 60, 90 or more day payment terms agreed with customers that can cause finance shortfalls.
If you’re looking to gain invoice finance, you’ll need up to date financials and accounts, and your customers will typically need to be reasonably large for anyone to finance your invoice.
4. Startup Loans
Entrepreneurs can make use of a startup loan to fund their new venture. This form of finance is a personal loan backed by the government, available to individuals looking to start or grow a UK-based business. Not only do successful applicants secure funding, but they also receive 12-months business mentoring, completely free.
Startup loans can offer up to £25,000 of borrowed credit for individuals starting a business. The loan has a competitive fixed interest rate per year and offers a repayment term of 1-5 years.
This source of funding is one of the most attractive available to startups, offering a considerable amount of finance, coupled with valuable expertise. You can apply on the government website provided that you’re 18, based in the UK and your business has been trading for less than 24 months.
5. Asset Finance
Asset finance is a form of financing for businesses which require capital to purchase high-value equipment or machinery, or for companies who need to release cash from assets they already own.
Asset finance differs from more traditional asset-based or secured loans, in that the asset acquired by the financier is typically the security used against the loan, meaning the business does not need to provide another form of security. You can find the main types of asset finance explored below.
6. Merchant Cash Advance
Any business using a card terminal to accept payments from customers can secure merchant cash advance from lenders through their terminal provider. The terminal provider can see exactly how much money is flowing into your business, and the lenders provide funds in exchange for a percentage of the company’s daily credit card income. This visibility acts as security for the loan; you’ll agree on a loan amount and repayment plan based on your average monthly profit and your cash flow.
Repayments are usually made as a percentage of revenue, meaning they remain proportionate with your business’ income. Such an arrangement works well for businesses without a stable income, such as seasonal businesses. As the card terminal secures the lending, there’s no need for any assets to back the finance, which is perfect for many SMEs.
Generally, you’re able to secure finance equivalent to your monthly revenue. If you’re making £2,000 per month, expect to secure £2,000 in merchant cash funding. The repayment structure tends to have a shorter repayment term than other sources of finance, usually under 24 months, and uses regular small payments, typically paid every business day.
7. Commercial Mortgages
If you’re looking to grow your business, you might be looking to invest in property. Commercial mortgages enable you to secure a 70-75% mortgage lasting up to 25 years. For investments, the amount you can borrow depends on the rental income generated by the property, up to 65% of the purchase price.
Lenders consider commercial mortgages higher-risk than regular home mortgages. The interest rate is therefore considerably higher, and aren’t fixed-rate for extended periods. That said, commercial mortgages offer better interest rates than business loans. The interest on your mortgage is tax-deductible, and you can rent out the property to generate extra income to match increased interest rates.
Be aware that mortgages are a form of secured loan, meaning the property serves as collateral for the lender. If you default on your payments, you’ll lose ownership. Some lenders require additional security in the form of other fixed assets. It’s worth using a mortgage broker to help you find the best offer, as they’ll advise you on which providers to apply to, and can help you find the highest loan to value ratio (LTV).
8. Business credit cards
Business credits cards can be a handy source of finance for trading entrepreneurs. Credit card limits can reach £10,000, which is effectively free financing provided you pay off the debt within the interest-free period.
If possible, you should avoid using business credit cards to start a business. The interest rates are high with strict repayment periods; APR can exceed 20%, and the interest-free period is typically 30-45 days. If you fail to pay, it is all too easy to get into crippling debt. This can also have a damaging, lasting effect on your company’s credit rating.
That said, if you are a trading business and you need such a facility, it can be a useful alternative to an overdraft as you can pay it off monthly. For temporary, short-term use, it’s a fantastic way to boost your instant purchasing power.
