There are many different options when it comes to funding your small business. SMBs access lending for a multitude of reasons – from smoothing cash flow to upgrading equipment or premises, expanding into new markets, products or services, or managing a large unexpected bill.
The right business finance solution for you will depend on how much finance you need, how long you need the funds for, your financial position and your priorities.
Common types of business finance
When sourcing funding for your business, there are two main types of business finance you’re likely to consider:
- Debt finance is money borrowed from an external lender such as a bank or credit union.
- Equity finance is when you or another party provide money in exchange for owning a part of the business.
Both forms of funding have advantages and disadvantages; below are some aspects to consider when deciding whether debt finance or equity finance is most suitable for your business.
The type of finance you choose could have a significant impact on your cash flow and tax obligations, so it’s important to seek advice from your accountant or a business advisor and ensure you fully understand these aspects before entering into a contract.
Debt finance is money borrowed from a lender that you must pay back with interest within an agreed timeframe.
The most common types of debt finance for SMBs include:
- Business loans – used to grow your business by investing in new premises, equipment or technology. Business loans can also be used to purchase an existing business or franchise.
- Overdrafts – a flexible line of credit that helps businesses to manage their cash flow.
- Credit cards – a popular option for financing short-term needs or a large once-off purchase.
- Debtor finance – also known as invoice finance, debtor finance allows you to access funding using your accounts receivable ledger as collateral. Debtor finance helps SMBs to streamline their cash flow and spend less time juggling money to pay the bills.
- Vehicle and equipment finance – used to fund the purchase of machinery, equipment or vehicles for your business via a loan, hire purchase or lease.
When you obtain debt finance, you enter into a contract with the lender that will have conditions on how the money must be repaid. The type of lending you choose will have an impact on factors including loan term, interest rate and security requirements (that is, whether the funding is secured against your business or personal assets).
Some advantages of debt finance:
- you retain full control of your business
- the interest you pay on your loan is tax deductible
- you can choose a short or long loan term depending on your business needs
- you don’t have to share your profits
Some disadvantages of debt finance:
- the debt must be paid back within an agreed timeframe
- it can be tough to secure debt financing if your business is relatively new
- lending will often be secured against business assets or the owner’s personal property
- you risk bankruptcy if you’re unable to repay the debt
Equity finance is when you invest your own money in the business - or someone else provides funding – in order to become a part owner of that business.
The most common sources of equity finance for SMBs include:
· Family and friends – money from family and friends is a common way to finance a start-up, however, it can put your personal relationships at risk.
· Private investors – sometimes called business angels, private investors will invest their own funds into start-up businesses they believe in.
· Crowdfunding – crowdfunding raises capital by using online channels to ask people to contribute money towards a project, usually in exchange for a launch product or reward. A relatively new approach to business funding, you can read more about crowdfunding on the Business Victoria website.
The main difference between debt finance and equity finance is that while equity funds usually won’t need to be returned, the investor will share your business’s profits and may have a say in business decisions.
Some advantages of equity finance:
- Self-funding – using your savings or selling personal assets to use the profits within your business.
- You don’t owe any money
- You’ll have more cash on hand as you don’t need to make loan repayments
- The investor(s) may bring valuable skills to your business
Some disadvantages of equity finance:
- you share business ownership with your investor(s)
- accepting equity funding from friends and family may affect your personal relationships
Today’s SMBs have a lot more choice when it comes to business finance than they have historically. While it’s great to have more flexibility, the number of funding options available can certainly be overwhelming.
If cash flow is holding you back from taking your business to the next level, we offer a free 30-minute consultation to look at the most suitable funding options for you. During this discussion, we’ll take the time to get to know you, your priorities and challenges, and recommend some simple alternatives to take the hassle out of managing your cash flow. Contact us today for more information or to book.