Business man in black suit working on a laptop

Loans and Equity Funding

by Angus Jones
Advertisements

To start a business, or expand a business to get through a rough patch, chances are you will need to get access to additional cash. The obvious choice is to borrow money but there may be other options. Money can be sourced from debt (you have to pay it back) or equity (someone takes a share in your business). This guide will look at what loans (debt) and equity funding options are available to provide additional cash or financing to start or expand your business.

Debt is when you take a loan or a mortgage with the intent of it being paid back over time. Normally some sort of collateral is used to secure that debt such as an asset which will be required to be sold if you default that debt.
Equity funding is when a share of your business is essentially sold to another permanently and is not required to be repaid. Future profits or losses will be shared with any equity partners.

WHY do you need a loan?

You may need a loan to start or expand your business to take advantage of a growth opportunity.  Although harder to get, funds may also be acquired when times are tough or you owe money.

WHAT are the available Debt options:

Self-funding: If you have personal finance you can put more money into the business yourself.  You are of course entitled to get that money back without personal tax implications unless you pay yourself interest.  Other forms of finance, like investors and lenders, will expect you to have some self-funding before they offer you money.

A loan: We all understand the basic principle. Normally a bank lends us some money and in return, we pay it back in instalments plus some interest.  A bank wants the confidence it will get its money back so will look at your business closely to understand your turnover and assets.  A bank may require personal collateral, like your home, to secure the loan.  Banks are however not the only source of lending.  Family and friends are a source but tread carefully. If things go sour you could ruin friendships and possibly others’ livelihoods.  Other organisations like finance companies will also offer loans but be aware, the easier it is to get the loan the higher the interest charges will be to compensate for the greater risk they are taking.

Line of credit:  This is similar to a loan but gives you access to a predetermined amount of credit. You can draw down on that credit and pay back whenever you need it.  You will pay interest only on the outstanding balance.

Overdraft: This is a line of credit attached to your bank account that allows your balance to go below zero.

Invoice financing is a way for a business to borrow money against the amounts due from outstanding customer invoices.  The funding company will provide a percentage of the invoice value to you upfront and when the customer pays you will receive the remainder less the funding company fees.

Leasing: Instead of buying equipment you essentially rent/borrow in return for monthly payments.  A lease normally has a set term of 3-5 years the financier purchases it on your behalf and you then lease it back from them for an agreed (and fixed) monthly payment. When the lease is up, you can either re-finance the residual amount and continue a new lease on that vehicle for another set period or pay a final instalment for the ‘residual value’ of the lease and take ownership of the car. You can trade it in and upgrade to a new vehicle. A lease makes it simple to upgrade equipment like a car at the end of the lease. More details can be found in our leasing guide.

Asset financing refers to the use of a company’s balance sheet assets, including short-term investments, inventory, and accounts receivable, to borrow money or get a loan. The business borrowing the funds is providing some of its assets to secure the loan. Default on the loan and your assets will be taken away.

Store Credit:  Many retailers, for example, Harvey Norman, will offer their own financing package potentially with an interest-free period.  Generally the interest rates are high and failure to pay on time comes with large penalties.

Trade Credit:  As an example, you buy your supplies from a company and they give you a 14-day invoice due for payment in 14 days. Thus giving you 14 days to pay for what you have already received.

Factor Companies: A factoring company will buy your outstanding invoices from you for a reduced cost and then chase up the debt themselves.  It is a fast way to get cash but at a high cost compared to other methods.

HOW do I get a loan?

How do I get a small business loan?

Sources of debt will include banks, building societies, and credit unions.

Finance companies also provide debt but must be registered, check the Australian Securities & Investments Commission (ASIC) register https://connectonline.asic.gov.au/RegistrySearch/faces/landing/ProfessionalRegisters.jspx?_adf.ctrl-state=1cuetuxolm_4

As part of the process of getting a loan your credit history, assets and income will be reviewed.

To understand and compare loan costs and  options from different institutions visit https://www.finder.com.au/business-loans

WHY do I need equity?

Equity is a great source of cash if you cannot either get a loan or a large enough loan.  It is also a method of spreading risk but assumes the equity provider believes they will get their money back plus some.

WHAT are the sources of Equity funding?

As a source of additional cash in return for a slice of the business, equity funding can be done in the following ways:

Self Funding: as before, you inject additional personal money taking a larger share (assumes you are not a sole trader)

Family or friends will take a share or partnership in your business in return for their money. Remember to consider the implications.

Private investors: Same as above but not a family or friend.  A new partner can often bring new valuable skills into a business.

Private equity/Venture capitalists:  These are firms who search for high growth potential businesses to invest in. They usually come with loads of experience and inject their management into the business. They often insist on a controlling percentage of the business.

Stockmarket: A small business is unlikely to list on the stock exchange but this complex procedure allows individuals to publically buy and sell shares in the business.  Shares are issued in return for a one time only cash payment.

Crowdfunding:  This is a very modern way of raising money for a business.  Essentially you ask a very large number of people to either invest or donate money in your business idea via the internet.  In return you give nothing if they donated, or if they invested, a product or a cheaper product when you are up and running, equity or money back with interest. See ASIC for more details https://asic.gov.au/regulatory-resources/financial-services/crowd-sourced-funding/

Government:  The government does not provide finance and is not likely to buy equity in your business however they do provide grants which may assist you greatly. The types of grants and assistance normally come in the following areas innovation, research & development, exporting, and business expansion.  Some information on grants can be found at https://www.business.gov.au/Grants-and-Programs

HINT

More information on funding options can be found at the Australian Small Business and Family Enterprise Ombudsman https://www.asbfeo.gov.au/resources/business-funding-guide

SUMMARY – Get loan or equity advice

We strongly recommend that you speak with your accountant or business advisor before committing to loans and equity funding options.  Always shop around for the best deal and always think carefully before doing business with family or friends.

Other guides like this

1 comment

Leave a Comment

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More

SBA NEWSLETTER Get the answers you need to succeed

We'll send the latest small business help guides, tips and news to your inbox.