No two businesses are the same, so it stands to reason that the ‘best fit’ finance solution will also be different for each. Variations in trading conditions, products, services and goals, together with seemingly endless options for lenders and types of finance, mean it can be difficult to know which is best for your business.
Keep your end goal in mind throughout the process, as the best fit for you will really depend on what you are trying to achieve. It can help to understand the key considerations when choosing a product, but also the jargon you’re likely to encounter.
To get you started, let’s take a look at some of the key terms and considerations, starting with the types of finance typically available to small to medium enterprises (SMEs).
Commercial and Business loans / Overdrafts: Secured and Unsecured
An overdraft or a business loan is generally the simplest form of finance for an SME and used for a variety of purposes, including the purchase of new property, business expansion, refinancing or consolidating existing debt (including shareholder loans) or cash flow – the list goes on.
These days, business loan facilities are very flexible. They’re different to overdrafts, in that they have an overall loan term, but the majority of business loans can be repaid and withdrawn against – they also generally come at a lower total cost than an overdraft.
Lenders will usually require security over a freehold property and/or over an existing business. The amount you can borrow will depend on the property or business type and value, business financials and the personal financial position of the Director/s.
However, it is worth noting that some lenders will offer unsecured smaller business loans or overdraft facilities, ranging from $5,000 to $100,000, subject to eligibility criteria.
Invoice finance facilities
Invoice finance is based on what your customers owe you at any given time. Unpaid invoices equal cash flow for your business, but you may have to wait between 14-90 days or more to actually receive the funds.
This model of financing is very much tailored to the individual business and lenders will require a detailed understanding of your invoice cycle and typical debtors. Once this is understood, the lender will establish a facility where you effectively upload your invoices as you issue them.
Once each invoice is uploaded, they will then advance to you up to 80%* of that invoice. Once the client pays the invoice, the lender is reimbursed and you receive the remaining 20% of the invoice amount less any applicable fees or charges.
While this is a great funding option, it is not a solution for all businesses and there are a number of eligibility criteria.
Some of these include (but are not limited to): At what point in the sale cycle you invoice clients, payment terms, diversity of your creditor book, whether you export goods and where to, if so.
In comparison to a business loan, invoice financing isn’t typically the lowest cost finance option but it can certainly help improve cash flow should other forms of security not be available.
Equipment financing is the use of a loan or lease to purchase or borrow hard assets for your business and uses those items as security. This type of financing might be used to purchase items such as a restaurant oven, company car, gym equipment, trucks, tippers, trailers or office/IT equipment.
Equipment loans generally have a term of 36 to 60 months with monthly repayments. You can opt to include a lump sum/balloon repayment at any point throughout the life of the loan.
For example, you may like to upgrade your vehicle every 3 years, so choose to schedule a lump sum in the 36th month to the amount of the anticipated residual value. This will reduce the monthly repayment amount over the term of the loan.
Insurance premium funding
Insurance premium funding enables you to pay for almost any insurance policy monthly, even if the insurance company does not offer a monthly option. Loan terms are anywhere between 6 and 12 months from the policy renewal start date.
The lender pays the full premium on your behalf, and you then repay the lender in monthly instalments over the term of the loan, with interest applied. This can be a great option to smooth lumpy annual insurance premiums, which can be a significant financial burden for some businesses.
Loan to value ratio (LVR)
Simply put, LVR is a restriction set by lenders that determines the maximum loan in proportion to the value of a certain asset. This is used to provide business owners and lenders a fall-back position, should the borrower find themselves no longer able to maintain the required loan repayments. In that case, the secured asset can be sold (by the client or lender) with confidence that the market value will at least repay the outstanding debt.
Depending on the industry, some lenders will also put a value to the business even if there is no physical security available. One example might be an established Pharmacy business, which some lenders will formally value and lend up to 80% of that value for a variety of purposes.
Lenders will require a formal valuation of the particular asset for all new clients and generally for existing clients, depending on the time passed since the original valuation and new lending request.
Breaking down interest rates
Unlike home loans or personal loans, interest rates for business lending are determined by lenders using several different elements. Generally, they quote based on the current Bank Bill Swap Rate (BBSY) + Customer margin + Line Fee, which is then tallied into a final interest rate. Alternatively, they might quote a base interest rate (which includes the BBSY rate) + Line fee.
Understanding what that actually means and comparing two different lender offers is another challenge.
The BBSY is an Australian benchmark interest rate, quoted publicly and used as base rate by each lender. Generally, the BBSY rate is set for a 90-day period and charged on the outstanding balance of the loan.
The customer margin is determined by the Lender on a case by case basis. The individual characteristics of a business are compiled to determine a risk rating, which is expressed as a percentage. When determining this figure, some considerations include (but are not limited to): Whether the business is leasehold or freehold, trading history, location, cash flow, seasonality, experience of the operators and LVR. The customer margin is generally set for the term of the loan and is charged on the outstanding balance of the loan.
Similar to the customer margin, the line fee is again determined by the lender but is charged on the limit of the facility, rather than the outstanding balance.
Other terms used by lenders to determine the end interest rate and charges for a client are a reset fee or rollover fee, generally both charged per 90-day period when the BBSY rate is reset.
Each lender may vary how they charge and what they label each element of the interest rate/fees.
While the BBSY will be the same, the customer margin, line fee and other fees could differ dramatically between lenders, or even two clients in the same industry. As finance brokers we understand how lenders charge each element of their interest rate/fees, and can therefore negotiate with multiple lenders to gain the optimal outcome from each.
Finance can be complex and confusing but like all things, consulting with the appropriate resource can simplify the process. A finance broker, who can also work in consultation with your accountant, can help secure the best type of finance to integrate with your business as smoothly as possible.
If you need assistance sourcing the right finance for your business or would like to discuss further, get in touch with our team.
A version of this article was published on 5 July 2021 at indaily.com.au.
*exact percentage lent will depend on the individual business/lender.