THIS GUIDE WILL EXPLAIN THE SOURCES OF FINANCE AVAILABLE FOR SMALL BUSINESSES
Before you apply for any business or property finance, you should ask if external funding is really the right path for your business. If you are already running a business you should investigate opportunities to tap into resources that already exist within your company before you look for external finance.
Ask yourself the following questions:
Could you improve your credit control procedures and get in money from your customers quicker?
Are you tying up too much cash in stock?
Is your business ready for expansion?
Do you have the right resources in place to handle the growth?
Could you negotiate better deals or payment terms with your suppliers?
If your business is on a high growth path and funding this expansion is difficult to obtain using conventional sources are you prepared to give up a share in the business by getting an equity investor involved?
Would factoring or invoice discounting help the cash flow of your business?
Would leasing or hiring equipment when needed be a better solution than buying it outright?
Is buying premises the right way to go? This involves a large deposit which might be better employed in growing your business. Renting premises may be a better option.
External funding is generally needed by businesses for the following reasons: Acquiring a new business, assets, maximising cash flow, recruiting staff or business expansion.
97% of small businesses call on their bank when they need to borrow money.
The source of funding will tend to vary depending upon the amount required and purpose. Banks offer two forms of finance terms, short term and long term. Long term finance tends to be in the form of loans and commercial mortgages and short term finance via overdrafts or business bridging finance.
If the business expansion is significant it may be that conventional bank funding is too restrictive to provide the expanding business with sufficient capital. This is where equity investment could be a possible option to consider.
In the following section, I will cover the different sources of finance available to businesses, their key features and I will explain the pros and cons affixed to each of them.
This guide will serve as a general guide to all businesses that need some form of finance, but predominately covers raising finance within the UK. For those businesses engaged in international trade i.e. importing / exporting there are specialised products available to help cash flow and reduce the potential impact of currency exchange movements. This guide does not specifically cover such products but for further information should be available from any major High Street UK bank.
Once of the most common business products taken and requested is an unsecured business loan which requires no personal or business asset as collateral. However, these loans require the borrower to show the lender a good credit rating, with excellent financial history and cash flow forecast.
The lender takes more of the risk involved in granting the loan and therefore, demands a higher interest rate. The lender has to take into account that the borrower might default and may not be able to repay the loan, and it is this risk which attracts the large repayment amortisation than on a secured business loan.
The borrower must show through detailed cash flow analysis, that a regular monthly payment including interest is possible during the loan period. The loan period is usually shorter than a secured loan and the amount of interest charged depends on the borrowing period.
A good solution if the funds are needed for more than a year e.g. for a specific asset purchase (e.g. vehicle / plant & machinery) or for other planned expenditure.
Business loans tend to be over an agreed term (generally) 2-10 years repayable by monthly instalments.
If used to fund an asset purchase (e.g. plant & machinery) the repayment term is usually geared to the life of the asset which is typically between 3 and 5 years.
The interest rate will vary depending upon your business, size of loan, security available and other factors but may average between 2.5% - 17% above base rate.
For small loans (up to £25,000) the bank may not ask for security but if a limited company may ask for director’s unsupported guarantees also known as a PG / DPG.
Some lenders may also fund 100% of the loan requested depending upon the financial health of the business and profit retained. Although the interest rates are higher for an unsecured loan than a secured loan, they can still be lower than other funding solutions. For example, a revolving credit loan, such as a credit card, overdraft or a business bridge. These lines of finance are unsecured and involve a continual borrowing and payment plan, attracting a high rate of interest.
Unsecured Term Loans, by contrast to the revolving credit, mean that the borrower repays the loan in equal instalments until the end of the loan term when the loan is fully paid off. This type of loan can be used by a business to consolidate debt into one single monthly repayment.
Apply for a Business Loan here.
The Recovery Loan Scheme was announced in the Chancellor’s 2021 Budget and is the follow-up to the CBILS, CLBILS and BBLS schemes. This new scheme is designed to help businesses manage cash flow, investment and growth post-lockdown. The finance can be used for any business purpose. Hiring new staff, boosting cash flow, buying more stock to meet an increase in demand and investing in new equipment for growth are just a few examples of “legitimate business purposes”.
To encourage more lending to UK SMEs, the Government will provide a 70% guarantee to the lender. It is worth remembering that any interest and fees associated with the finance will not be covered by the government.
Any finance taken out up to £250,000 won’t need to have a personal guarantee, but you may have to provide one for amounts over this. However, you won’t be required to offer your principal private residence as security. There’s a maximum turnover of £45M and the scheme is only available to SMEs.
Businesses operating in most sectors can apply for the Recovery Loan Scheme. You can also apply if you’ve already received support from the CBILS, CLBILS or BBLS initiatives.
Features & Benefits of the Recovery Loan Scheme
Scheme runs until 30 June 2022
Available to SMEs only, turnover cap of £45M
Delivered through four finance types: Term Loans, Overdrafts, Invoice Finance and Asset Finance
Loans from £1,000 to £10,000,000 (depending on finance type)
No personal guarantees on loans up to £250k
Government-backed
Loan term of up to 6 years (depending on finance type)
Alternative lenders for unsecured loans, such as merchant cash advance, boutique lender and payday lenders tend to charge the highest rates for their unsecured loans. These lending companies often make the borrower take bigger risks by agreeing to automatic withdrawal from a current account. The result is a never-ending cycle of borrowing and excessive repayment charges.
With a secured loan, repossession of collateral helps the lender recoup the losses if there is payment default. However, with an unsecured business loan, unless there has been a personal guarantee made by a company director or owner, there is little to be done in the way of recoupment. Often the lender will resort to debt collection, and in dire circumstances, the borrower will be placed in a tenuous position and probably have to apply for bankruptcy.
Strenuous credit checks by the lender on the borrower’s financial status. Companies with limited assets of one that does not wish to provide a form of collateral will be able to apply for an unsecured business loan.
In some situations, dependent on meeting the credit rating criteria, directors and company owners, will have to sign personal guarantees.
Pros
Spreads the repayments over a manageable term
Separates the specific purpose borrowing away from day to day cash flow
The repayment period can be geared to coincide with the expected life of the asset
A term commitment from the bank means that it cannot be called in provided that the monthly repayments are being met. Overdrafts, by contrast, are repayable upon demand
Interest on the loan can be offset against profits for corporation tax purposes
No risk to existing assets like a home, vehicles, other commercial property, or long-term assets
Because the borrower doesn’t need to document their assets in an unsecured business loan, some parts of the loan underwriting process may be easier
Cons
Maybe a more expensive and inflexible option for cash generative businesses who might be able to fund the requirement more cost effectively by way of overdraft
Some banks will charge a penalty for early repayment should you wish to pay back the loan early
The interest rates will normally be higher than for secured loans
For those without squeaky clean credit, unsecured business loans can have a particularly high debt load
TIP – Many businesses are unable to obtain a loan or overdraft because they are not able to provide their bank with adequate security. The Government backed Recovery Loan Scheme might help in these situations.
A secured business loan is when the borrower pledges an asset (such as a plant, equipment, stocks or vehicles) against the debt. If the debt is not repaid, the lender may claim the secured asset. Secured business loans can be used for a wide range of purposes, including working capital, expansion capital, asset purchase and more. The collateral is the most important aspect of secured business loans because it reduces the risk for the lending company, therefore reducing the interest rate that the borrower pays.
Banks and finance houses lend money and make their money by charging interest. An unsecured loan is riskier for a lender and therefore attracts higher interest rates than a secured loan. Even with a poor credit rating, banks are more likely to lend money with a secured loan and often lower the APR (annual percentage rate) to a small business borrower who has collateral to secure a loan. It is quite the opposite with an unsecured loan. The difficulty that owners have is making the right choice between a secured or unsecured loan.
A secured business loan is an excellent solution for those with a poor credit rating. It is a great option if you want to start a new business or expand your business. If your secured business loan is approved, you will have a lower APR rate and very likely a longer repayment period. This can make it affordable for start-up businesses to get the cash they need during a time when profits are just starting to grow.
Unsecured loans appear more attractive, but although they are often approved quickly, there is a bigger cost involved. Unsecured mean that there is no collateral offered, thus making it a risky business for the lender. Therefore, banks are obliged to charge higher interest rates, and some of them get the most out of it by charging exorbitant interest to reduce the risk on their capital.
Lenders realize the needs of a small business and often approve a secured business loan giving a longer repayment period and a lower APR. They know that it is better to get their money back rather than foreclose due to financial difficulties caused by high-interest rates and short repayment period.
As a start-up, having a good business plan with a secure cash flow, will generate income and allow time to pay back the loan. This alleviates the stress of being in default and having to a) find extra money to get through a lean period or b) file for bankruptcy, which leaves both the business owner and the lender out of pocket.
Pros
You can borrow more substantial amounts at a relatively lower cost
It is easier to obtain than unsecured finance if your business has a limited track record or the principals have patchy credit ratings
Flexibility of a much longer repayment period, thus reducing the monthly charge
Cons
Potential loss of the secured asset if repayments are not made
The interest rate is more likely to be variable. This can work to your advantage if interest rates go down, but you will need to plan carefully at a time when rates rise
For more funding options, please visit our website here.
Written by
Maurice Sardison
The team at Sardison Capital have been helping business owners to raise finance for over 10 years. So if you're interested in learning more about your options, get in touch with the team today to see how we can help you.
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