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FINANCE UPDATES
FEBRUARY 2014
Debt financing
This guide looks at debt finance as a way to
raise funds for your business.
For a business to grow it often needs
to seek additional, sometimes external
finance. But securing the right level and
type of finance can be challenging. You
need to weigh up all of your options
before making a decision that could have
a significant impact on your business.
What is debt finance?
Debt finance is one of the most common
forms of sourcing additional funds and
includes bank finance such as loans and
overdrafts. Debt financing is essentially
borrowing money that you will have to pay
back over time, with interest.
A bank or other lender will assess the
business’s ability to repay the amount
borrowed plus interest during the application
process. Typical characteristics of debt
finance include:
•
You do not have to give up a share in
your business, unlike with equity finance
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•
The borrower must meet the agreed
repayments to the lender and abide by
any terms and conditions set.
However, it is important to note that these
lending terms might give the lender the right to
immediate repayment.
Types of debt finance
Loans
The number of loans to businesses has
decreased since the financial crisis hit in
2008 and banks are, seemingly, still reluctant
to lend. However, this has been recognised by
both the Government and the banking industry.
The Bank of England recently revealed that the
Funding for Lending Scheme’s focus will be
retargeted to help businesses as opposed to
mortgage borrowers.
To be successful in your loan application you
will typically have to prove to the lender that
the business will generate the income needed
to repay the amount, including interest.
Therefore, your loan application is of great
importance and will need to include:
•
A credible and comprehensive
business plan, including cashflow
projections, clearly demonstrating
that the business can meet the
repayments
•
Evidence of a successful track
record in business
•
Security for any money borrowed
against personal or business assets.
Pros and cons of loans
As with all types of business finance
there are pros and cons to taking out a
secured loan:
Pro
Con
Terms can be
tailored to your
business
Banks can be
reluctant to lend
if you have no
financial track
record
Repayments
are known
in advance
to allow for
budgeting and
planning
Loans are less
flexible than
overdrafts
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Debt financing
Pro
Con
Overdrafts
A loan usually
costs less
in interest
payments than
an overdraft
used over the
same term
A set repayment
plan could
potentially cause
problems if
you encounter
cashflow
difficulties
An overdraft is a borrowing facility linked
to a bank account that is designed to help
manage short term borrowing needs. They
are usually agreed for six to 12 months,
after which they may be renewed on
negotiation.
You will normally
Tax relief is
need to put up
available on the
security against
interest payments
the loan
The amount you will have to repay
will depend on the size and period
of the loan and the rate of interest
charged. This is why it is important
to shop around for the best loan deal
for your business and consider every
element carefully before you commit.
Like loans, there are pros and cons to
overdrafts. These include:
Pro
Con
Overdrafts are
flexible and you
can borrow what
you need at the
time
They are repayable
on demand
They are often
quicker to arrange
than loans
You may be
charged if you go
over your agreed
limit
They are reviewed
regularly
You can only get
an overdraft from
the lender you hold
your business bank
account with
Things to consider include:
The interest rate
Asset finance
Leasing or renting assets instead of buying them
outright can help your business to maintain a steady
cashflow.
Invoice financing
This is where a third party agrees to buy your unpaid
invoices for a fee. There are two main types –
factoring and invoice discounting.
Peer-to-peer lending
This is a relatively new type of debt finance and
allows hundreds or thousands of individual investors to
loan to the business. There are a number of websites
offering peer-to-peer lending opportunities, but it is
important that you fully understand what is involved.
The Enterprise Finance Guarantee Scheme
The Enterprise Finance Guarantee (EFG) Scheme is
a loan guarantee scheme that facilitates lending to
businesses that have been turned down for a normal
commercial loan due to a lack of security or proven
track record.
This can be fixed or variable so
make sure you choose the type of
rate that suits you. Fixed means that
the rate remains constant throughout
the repayment period, while variable
means it could fluctuate according to
changes to the Bank rate or LIBOR
(London Interbank Offered Rate).
Overdraft interest rates and agreed limits
can vary, so it is worth checking that
you are getting the best deal for your
circumstances from your bank account
provider. Lower rates are sometimes
available for secured overdraft facilities.
Eligibility will be determined by the lender but the EFG
is open to viable businesses that:
The APR
Business credit cards
APR (annual percentage rate) is the
rate that will be charged annually
once all fees have been taken into
account and is the key figure to use in
a comparison.
These work in a similar way to personal
credit cards and can be used to help with
cashflow on a short term basis. As with
overdrafts, they offer flexibility and cost
control. However, the interest rate charged
will be higher than most other types of loan.
Seek expert advice
A financial adviser will be able to
help you find the best loan for your
business’s circumstances.
Commercial property loans
These operate in a similar way to a
personal mortgage and can be used to
purchase commercial property such as
shops, factories, offices and warehouses.
Important information
The way in which tax charges (or tax relief,
as appropriate) are applied depends
upon individual circumstances and may be
subject to change in the future.
•
operate in the UK
•
have a turnover of less than £41 million
•
are seeking finance between £1,000 and
£1 million
•
want repayment terms from three months to
10 years
•
eligibility will also be dependent on the sector
you operate in, although most sectors are eligible.
Structuring debt finance
The way your debt finance is structured can make
a big difference and there is often a case for
restructuring a business’s debt.
As with all financial decisions it is important to seek
expert advice if you are unsure. Please contact us to
find out more.
This document is solely for information purposes
and nothing in this document is intended to
constitute advice or a recommendation.
Whilst considerable care has been taken to
ensure that the information contained within
Money Wise Independent Financial Advisers Ltd is authorised and regulated by the Financial Conduct Authority.
this document is accurate and
up-to-date, no warranty is given as
to the accuracy or completeness
of any information. Errors and
omissions excepted.