You’ve established your business and sought some initial funding to get it off the ground. But you now need funds to take things further.
The only recourse you have is to borrow money, but you are worried. You’re risk averse and concerned about stigma attached to going into debt to fund your activities. In many cases these misgivings are unfounded.
There are some pitfalls of debt finance that you should be aware of before you start seeking a loan.
But in general, here are a number of misconceptions about debt finance:
- Borrowing is bad for profit
- Debt is risky and expensive
- Debt funding should be last resort
- Banks are he best place to get a loan
- Start-ups can’t get funding
- You can’t get finance with a bad credit score
- Debt has to be secured
Borrowing is bad for profit
If the funding is going to bring you in sufficient margin to pay for the cost of borrowing, then it’s definitely not ‘bad’. Strategic borrowing can help you expand your sales orders and increase your customer base – in short, make more profit. Successful businesses know how to use short-term loans to help them seize the moment. What is bad for business is a lack of investment and letting great opportunities pass you by.
Debt is risky and expensive
When you are looking at debt options you need to check if there are any arrangement fees, early repayment fees or exit fees. Not all lenders charge these, but where there are fees it’s important to shop around. Many businesses view short-term loans as an essential part of business planning. Imagine if you weren’t able to take on a new order simply because of cashflow?
That’s why, when you’re working out how much the loan is going to cost, it’s just as important to work out how much it could cost you if you don’t borrow. You can also get Corporation Tax Relief on the interest – so it’s win-win.
Debt funding should be a last resort
It is hard wired into us over time that loans equal debt and are therefore a ‘bad’ thing.
This isn’t necessarily so. A loan is in reality just another means of funding; funding which could be essential for the success of your business.
You wouldn’t think twice about borrowing a lump sum over 25 years to buy a house. Why? Because it’s called a ‘mortgage’, not a loan. There is no stigma attached to it, but it is still essentially a loan.
However, you expect the property to go up in value. Do you have the same expectations for your business?
Successful businesses don’t let semantics stand in the way of their operations. To them, a loan is just another strategic source of funding. It’s a means to an end – creating opportunity.
Banks are the best place to get a loan
Once you have made the decision to take out a loan and you’re looking to borrow, the first source that is likely to spring to mind is your bank. You already have a relationship with them so it stands to reason that the process will be quick and easy. The reality is that this is often not the case.
And you should remember that there are other lenders out there who can offer you more competitive rates and get you the money you need, quicker, and with a lot less paperwork.
As alternatives to high street lenders you could look at:
- Enterprise Guarantee loans – great for businesses looking for the benefit of unsecured finance where the owners do not have sufficient personal assets to support the loan or the business is relatively new
- Alternative and Peer-to-peer lenders – a very viable option for smaller, low interest rate loans as long as you have an excellent credit rating
Start-up businesses can’t get debt funding
Granted, it can be hard to get hard to get financing for a start-up. But it’s not impossible.
There are several financing options available to young businesses. A crowdfunding campaign is an option. Or you could opt for a small business credit card or a start-up loan.
Crowdfunding is great for small start-ups looking to get off the ground, but you’ll still need to do your research. There are lots of crowdfunding sites out there and the rules will differ from one to the next. The general plan is that you pitch your business idea, on your chosen crowdfunding website, and set a goal for the total amount you’re looking to raise. You’ll need to set a deadline too, because if the total required is not raised, the funding won’t go ahead.
Potential funders regularly review crowdfunding pitches, and if one catches their eye, they will subscribe to your offer.
As long as you have decent credit and sufficient income from various sources, you should be able to qualify for a small business credit card. While interest rates on small business credit cards aren’t the lowest (15 – 18% is typical), they can be cheaper than some other types of financing available to start-ups. As an added bonus: the right credit card can help you build up your business credit rating.
You can apply to the government for a start- up loan of between £500 and £25,000. Unlike a business loan, this kind of loan is an unsecured personal loan. There is a fixed charge of 6% per year and you can repay it over 1-5 years – and there are no application or early repayment fees.
You can’t get finance with a bad credit score
While it’s true that your options for finance are limited if you have a bad credit score, it doesn’t mean you have no options at all.
But first, you need to know what your score is. You wouldn’t apply for a mortgage to buy a home without checking your credit score first. You shouldn’t apply for business funding without knowing it either.
Knowing your credit rating is important because banks will use this information when you apply for funding in the form of a loan or credit card.
They’ll use credit reference agencies to check how reliable you have been at managing loans and making repayments, in order to mitigate their risk and calculate their rates.
Having a strong credit rating is important for many reasons, not least because it’ll help you get funding, and can also help you win tenders and negotiate business contracts.
A credit check will review one of the following:
- Your personal credit scores. Personal credit checks are often used to evaluate applications for business loans and credit cards, so you need to make sure your financial records are up to date, and you keep up payments on your personal loans, cards and mortgage.
- Business credit scores. Business credit checks are often used when a business owner is requesting “trade credit” such as net payment terms from a vendor or supplier. Other small business financing options may also involve a business credit check.
There are times that credit scores don’t matter. For instance, crowdfunding portals rarely involve a credit check. Invoice financing and many cash flow loans are primarily interested in business revenues or receivables, so the check credit will be secondary.
Debt has to be secured against assets
Securitisation for lending is not always necessary. Most lenders will only seek security for loans on a case by case basis depending on your perceived risk and the type of facility you’re looking for. It might be that your ambitions can be supported through government led schemes, which are suitable for a range of different circumstances.
For more information about debt financing and to discuss your options contact one of our experts today on 0203 327 0567 or email [email protected]. They will be happy to help.