How do you choose the right funding structure for your business?

What key factors should you consider when you want to choose the right funding structure for your business?

Funding, also known as financing, is the act of supplying money or resources to support an individual or business. The purpose of borrowing is to assist business growth such as borrowing to purchase an asset that will help you produce more, and in return sell more.

Debt and Equity Finance are the 2 main types of business funding available

Debt Finance

This is when you borrow money from a bank, or another external lender and you are then required to repay the original amount borrowed plus the interest through regular payments. Business finance can be in the form of business loans, invoice financing, asset financing, lines of credit, and more. Credit cards are an example of lines of credit and car loans are an example of asset financing.

Equity Finance

This is when you give part of your business (share ownership) to investors in exchange for money. This method will reduce profitability in the long-term but business owners will have significantly less control of business operations and procedures.

What Type of Financing is Right for My Business?

In an ideal world, you would be able to pick whatever type of financing you prefer. In reality, lenders need to be shown that you can pay back the loan and therefore there are certain restrictions lenders will have. Business loans can be used for investing in your business, improving cash flow, tax debt, purchasing equipment and buying stock.

Before you decide what type of finance your business needs, you need to be aware of the factors that will impact your success in obtaining business funding.

6 Factors affecting whether you will be able to get business funding:

1) Purpose

Lenders will want to know why you want to purchase with a loan and how does it help your business generate revenue. For example, a tradesperson wants to purchase a truck to be able to transport equipment to worksites to help make more revenue. What if the worker wanted to buy a two door Porsche? The loan for the work truck is good for business and therefore more likely to be approved.

2) Credit Score

Most lenders will look at your credit score. If you have a bad score, it is unlikely you will be approved for a business loan.

3) Security

Lenders will want to see you have security for your loan to ensure you will repay your debt. Security can be property, equipment or your business, which is used as collateral.

4) Trading History

At least 2 years of profitable trading is best. For a start-up business with no trading history, getting approved for finance is very, very difficult, and becomes less likely.

5) Expenses / Cash Flow

Do not take money out of your business before you have paid for all your expenses. You should always be paying your super, wages, and tax liabilities on time. If you have any ATO debts such as an overdue BAS, Tax, or Superannuation payment, you are less likely to be approved for a loan. Also, being cash flow positive is very important. Download our cash flow eBook for more information on improving your cash flow.

6) Drawings

Lenders will look at whether you are drawing too much out of your business. You are more likely to be approved if you are paying yourself a fair salary and pulling out a reasonable amount of funds for your pay.

You may not want to borrow or maybe you can’t be approved for a loan. Lucky for you, there are alternatives!

Alternatives to Borrowing

Grant Incentives

Government grants are available but there are strict eligibility requirements. Also, these grants typically will send you the money after you have already spent it. It is important you manage your cash flow properly and understand the grant application process required before committing to expenditures. Do you need to make changes to your plans to meet grant criteria?

Invoice Financing

Factor companies offer financing by purchasing a business’s unpaid invoices at a reduced rate for cash. The company is now in charge of those invoices and will receive any profits from them. This is a great way for you to improve your cash flow if you are waiting for large amounts of invoice payments.

Trade Finance

For people importing goods from overseas, typically you have to pay before it is shipped. It can take months to receive the shipped goods, which can negatively affect your cash flow as you cannot sell them, but you have paid for them. Trade financing offers your business the chance to delay payment for goods. For this one, you are required to have a good reputation with the supplier.

Unsecured Funding

This is for businesses where the borrower does not have or want to offer up any security (collateral) for a loan. Since this is an increased risk for the lender, there are much higher interest rates, smaller loan amounts, and shorter terms of the loan.

Just like no two businesses are the same, the right funding structure for your business may be unique. Are you uncertain about how to choose the right funding structure for your business? Contact us – we’ll look at your specific situation and help you work out the best funding strategy for your business.