SMALL BUSINESS LOANS

Small business finance is now surprisingly accessible in Australia. Banks generally make it difficult and often say no to small businesses however now there are many non bank lenders offering the finance you need. Whether it is to buy inventory, renovate, day to day expenses (or anything business related) you’re most likely going to be able to get some sort of finance.

But which business loan option is best for you?

The Top 10 Most Popular Small Business Finance Options

Unsecured Business Loans1

What is it?

A flexible, short-term loan, usually between $5k and $250k. You can expect to borrow for up to 12 months, with regular repayments and interest calculated daily or weekly.

What can you use it for?

You can use unsecured business loans to meet any short term business need, such as paying tax installments, boosting your cash flow or pursuing growth opportunities. Avoid using it for major, long-term purchases like property, which could leave you with a financing shortfall when the loan expires.

Pros:
  • Easily accessible for many SMEs that wouldn’t qualify for bank finance
  • Simple online application, on the spot assessments and fast funding
  • You won’t need to offer personal or business assets as collateral
Cons:
  • Unsecured finance is a higher risk for the lender, so interest rates are likely to be higher
  • Terms, rates and conditions may be obscure, leaving you paying more than you need to for business finance
  • Only suitable for short-term needs, not for major purchases as there is no guarantee you’ll be able to renew the loan when the term expires

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Line of credit2

What is it?

A flexible facility that works in the same way a personal overdraft does, giving you at-call access to an agreed amount of funds. You can draw down, repay and redraw the funds as needed, and generally only pay interest on the amount you use.

What can you use it for?

You can draw down funds for any purpose, but it’s best to keep the balance to a minimum as interest is usually calculated daily. It’s ideal for covering short-term gaps in your cash flow.

Pros:
  • You can apply online through a quick and simple process
  • Peace of mind that you have access to funds when you need them, without the drain of regular repayments
  • Flexibility to draw down, repay and redraw funds as needed, only paying interest (often calculated daily) on the funds you actually use
Cons:
  • You’ll usually pay a facility fee in addition to interest – even if you don’t draw down the funds
  • There is no fixed loan period, so the facility can be withdrawn at any time, making it unsuitable for long-term finance needs
  • Fees and loan conditions vary widely. You may have to make regular repayments or pay off the balance at agreed intervals.

Factoring3

What is it?

Factoring, or ‘invoice finance’, is a debt-free financing option. A factoring company will advance you up to 80% of the amount due on your invoices, and take on responsibility for collecting the receivable from your customers.

What can you use it for?

Invoice finance isn’t a loan, it’s simply an advance on your income from sales, so you can use it for any purpose – just as you would if you waited to collect the payment from the customer.

Pros:
  • Allows you to be more competitive by offering credit terms to your customers, but still access the cash from sales without delay
  • Avoids the hassle of having to chase and collect debts, and the risk of non-payment
  • Flexible – many factoring companies will allow you to choose which invoices to sell, and how often, so you can use it only when you need to boost your working capital
Cons:
  • It’s generally more expensive than debt finance
  • Some lenders only offer ‘recourse’ factoring, where you have to repay the funds if the customer fails to pay their invoice
  • Lenders will usually assess the creditworthiness of your customers as well as your own business, so the cost / availability can be affected by factors you can’t control

Merchant Cash Advance4

What is it?

A short-term loan which you’ll repay each day with a percentage of your income – ideal for businesses that make regular but fluctuating daily sales.

What can you use it for?

There are no restrictions on the way you use the funds from a merchant cash advance so it’s suitable for any business purpose.

Pros:
  • Avoids the risk of having to make fixed loan repayments on a regular schedule – payments are directly linked to your income
  • Easy online application process, provided you meet the lenders’ requirements (such as minimum trading history)
  • Quick access to funds with no restriction on use
Cons:
  • Very expensive financing option – rates can be high as 60% –200% APR and the fees and conditions can be complex
  • Suitable only for retail or hospitality type businesses that take daily payments by credit card or EFTPOS
  • Lenders are not regulated like Australia banks, so they may impose restrictive terms on your business to lower the risk to them

Lease Finance5

What is it?

Lease finance is a method of purchasing assets such as plant or equipment for your business.

The lender will purchase the asset in question and allow you to use it for an agreed period, while you make regular rental payments for use of the asset. At the end of the contract the asset belongs to the finance company, and you may or may not have the option to purchase it for a residual amount.

What can you use it for?

You can use lease finance to gain access to assets or property for your business without having to buy them yourself.

Pros:
  • Gives immediate access to valuable plant or equipment while spreading the cost over an agreed period, usually with little or no deposit required
  • The finance company owns the asset, so lease finance is lower risk and therefore often easier to secure than loan finance
  • You can usually agree a leasing period and repayment schedule to suit your business
Cons:
  • The term is usually fixed, so you will have to continue paying for use of the equipment until the end of the contract even if becomes obsolete
  • You don’t own the asset during the leasing period, although you may have the option to purchase it at the end of the contract, depending on the type of lease.
  • Lease finance is generally more expensive than loan finance, and with many lease arrangements you’ll have no equity in the asset at the end of the contract.

Hire Purchase6

What is it?

Hire purchase is a medium-term loan that enables you to acquire equipment or machinery for your business with only a small up-front investment.

The finance company will purchase the equipment on your behalf, using the asset as security. You will enjoy use of the asset immediately, but will pay for it in installments over an agreed period. At the end of the contract you will own the asset.

What can you use it for?

Hire purchase is a popular method for buying business equipment, plant or machinery.

Pros:
  • At the end of the contract you own the asset, so you can continue to use it or sell it to recoup some of your investment
  • The asset acts as collateral which reduces the risk to the lender, so hire purchase finance may be easier to access than a business loan
  • Spread the cost of the asset over its lifetime with a repayment schedule that matches your cash flow
Cons:
  • You may be locked into the contract so that you’ll continue paying for the asset even if you no longer need it
  • You will need to pay a percentage of the asset’s value as a deposit at the start of the contract, unlike with lease finance
  • You can expect to pay considerably higher interest rates and costs than you would with loan finance

Commercial Bill of Exchange7

What is it?

A financing facility usually offered by traditional lenders to well-established businesses in need of a major cash injection.

What can you use it for?

Any approved commercial purpose, short or long term, including major purchases or investments.

Pros:
  • You can adjust the amount you borrow at each rollover (within an agreed limit) to meet your cash flow needs
  • Flexibility to fix terms that suit your business, including the intervals between maturity and rollover (eg. 30, 60, 90, 120, 150 or 180 days)
  • There may be the option to fix your interest rate for agreed periods, or to apply a cap or collar to variable interest rates to minimise your risk
Cons:
  • You’ll pay standard interest rates plus a margin, making it more expensive than term loan finance
  • You’ll receive less than the face value of the bill at each rollover, but have to pay back the full face value plus interest at maturity
  • Commercial bills are generally only suitable for well-established businesses looking to borrow at least $500,000

Traditional Business Loan8

What is it?

The original model of business loan product, usually offered by high street banks like ANZ, Bank of Australia, Westpac and ASB. Often a longer-term option, with personal or business assets required as security.

What can you use it for?

Longer term, larger business purchases such as property, major plant and equipment or corporate acquisitions.

Pros:
  • Secured loans are less risky, so they are usually the lowest cost option for long term finance
  • Many lenders offer a range of terms and conditions, such as fixed, variable or combination interest rates, and interest-only or interest and principal repayments
  • Allows you to spread the cost of the asset over its lifetime and match your repayments to your business income
Cons:
  • Slow and time-consuming application and approval process, can take weeks or even months to acquire funding
  • Typically risk-averse, banks may have very strict lending criteria including minimum turnover and several years’ trading history, so many applications are declined
  • If you opt for fixed interest rates you may have no flexibility to make early repayments or terminate the agreement, which could leave you locked into finance you no longer need

Personal Loan9

What is it?

A short or long-term loan issued to you personally rather than your business and, if secured, using your personal property or assets as collateral.

What can you use it for?

You can use the loan funds for any purpose, such as buying stock, boosting working capital, or purchasing equipment for your business.

Pros:
  • If your interest rate is variable you can usually make extra payments or terminate the loan early if you no longer need it
  • Loan finance is usually lower in cost than other forms of financing like factoring, hire purchase or leasing
  • May be available even if your business is not well established, provided that you have enough assets and a steady income from another source
Cons:
  • If you use personal assets (like your home) to secure the loan, you could lose them as well as your livelihood if your business fails
  • If your business is new and is your only source of income, you might fail the lenders’ ‘capacity’ tests and be refused finance
  • Any blemishes on your personal credit rating could impact on your ability to secure finance or the costs you pay

Business Credit Card10

What is it?

Business credit cards work on the same model as personal ones, giving you flexibility to spend, repay and redraw funds up to an agreed limit. Provided you pay off the full balance each month you can keep interest payments to a minimum.

What can you use it for?

There are few restrictions on how you use your business credit card, but unless you repay the balance each month it can be very expensive, so it’s best to use it for short-term purchases like consumables (or as an emergency back up when your cash flow is suffering).

Pros:
  • Some cards offer interest-free periods or rewards programs that can make them an economical way to buy supplies – if used with great care
  • You only pay interest, usually calculated daily, on the amount of funds you use, not the full amount available
  • Credit cards make it very quick and easy to buy consumables on or offline, and can be offered to all your staff members with different limits and restrictions
Cons:
  • Many business credit cards facilities charge hefty annual fees (which you’ll have to pay even if you don’t use the card) plus very high interest rates on unpaid balances
  • As the owner of the business you may have to stand as guarantor for the card, meaning that your personal funds or assets could be at risk if you can’t repay the balance
  • Credit card facilities can be withdrawn at any time, for any reason

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What are small business loans for?

There are many reasons SMEs seek business finance. Here are some of the most common:

Buy property
Finance renovations
Fund vital machinery or equipment
Hire new employees
Pay for fixed costs like utilities
Business Capital
Advertise their business
Pursue a business opportunity
Pay their staff
Buy or lease equipment
Cover tax payments
Boost working capital

Many SMEs opt for an unsecured small business loan because it gives them maximum flexibility.

With an unsecured loan you can spend the funds on anything you need, from covering fixed costs when income fluctuates, to pursuing unexpected business opportunities or grabbing great deals on stock.

However, the most suitable type of finance for your business will depend on your reason for borrowing. Below is a handy overview of the options.

Choosing the right type of finance

These three steps will help you evaluate your requirements and choose which type of finance to apply for.

1

Assess your business needs

It’s crucial that the term and type of your finance are carefully matched with your business needs and reason for borrowing.

Conduct a thorough assessment of what funding you really need in order to maintain or grow your business. You may find you need more than one facility to cover all your requirements – for example, a long-term loan to purchase a business property, medium-term hire purchase finance so you can upgrade your IT, and a business credit card for cash-flow emergencies – or that a single option like a line of credit will cover all your needs.

2

Create your business case

Loan repayments will be a regular drain on your working capital, especially if interest rates rise. Be sure to create realistic cash flow projections and a thorough business case as part of your planning process, to make sure that applying for finance is the right decision as this time.

You may find that repayments on the loan you’re considering just won’t be viable on top of your existing financial commitments. If debt finance will be too much of a strain, you could consider alternatives like invoice factoring or merchant cash advances to help keep the cash flowing – or even turn elsewhere for cash, like an investor or crowd funding.

3

Minimise your risk profile

Before a finance provider will lend to you, they’ll need to know that the return from doing business with you is worth the risk. Each lender will have its own risk tolerance level, but the basic formula is that the less creditworthy you are, the more you’ll have to pay in interest and fees in order to secure finance.

To make it cheaper and easier to get a business loan, take a thorough look at your operations to see if you can lower your risk profile. For example, you may be able to:

  • Cut regular outgoings so that you have more cash available to service repayments
  • Offer business or personal assets as collateral for your loan
  • Reduce the amount of working capital you have tied up in excess stock
  • End relationships with consistently late-paying clients to reduce your debtor days.

Choosing your lender

Once you’ve decided on the most suitable type of finance, you then need to choose the right lender and loan product – and the choices can seem overwhelming.

There are scores of alternative finance providers out there, but some focus only on particular types of customer (such as businesses in specific industries, businesses with a minimum turnover or trading period, or SMEs with poor credit ratings).

Before you can apply you’ll need to:

  • Find out if you meet their lending criteria (which will be different for every provider).
  • Check who you are dealing with and whether they impose any restrictive conditions on their customers (alternative lenders are not as tightly regulated as Australia’s banks so you could end up locked into restrictive terms).
  • Compare the fees and other important factors, such as the type of interest (fixed or variable) and the level of flexibility (your ability to make early repayments, redraw funds or terminate the facility).
  • If in doubt, seek independent financial advice.

Applying for a small business loan

Successfully securing business finance generally comes down to preparation.

First, use a business loan repayment calculator to work out how much your business can afford to repay.

In addition to the steps you’ve already taken (analysing your needs, preparing your business case, minimising your risk profile and thoroughly researching the lender and loan product) you’ll need to gather or prepare supporting documents to submit with your application.

Depending on the type of finance and the lender, these could include:

Once your preparations are complete, you’ll need to follow the lender’s application process. For traditional lenders, this can be very cumbersome and time-consuming, and often beginning with a face-to-face meeting with a business loan advisor. Online applications are usually far more streamlined.

Online loan applications

If you’re applying for a business loan online, the process will usually go something like this:

If your loan application is not successful

There are many reasons why your application might be declined – for example if your credit rating isn’t high enough for that particular lender, if your income is too dependent on a small number of customers, or if the outlook for your market sector is poor. It could also be that your business is just too new – start-ups find it almost impossible to secure business loans because the risk is so great.

The number one reason applications are declined, though, is simply not having enough free funds to service a loan. Most lenders will use the ‘five cs’ (character, collateral, capital, conditions and capacity) to assess your creditworthiness, and even if you meet every other criterion with ease, capacity is the one that counts most.

Even if your overall profits are good, cash flow is what really matters – if your income fluctuates because of seasonal sales or slow-paying customers, for example, the lender may believe that you won’t be able to meet all your payments when they fall due.

What can you do if your loan is declined?

You could consider applying to another lender with different requirements – but be aware that if you make too many enquiries you could do serious damage to your credit rating, especially if you are unsuccessful.

If you wanted the finance for a discretionary purchase or to pursue a growth opportunity, you may just need to wait until your business is more established and your income more reliable before applying again.

However, if you need funds urgently, or you believe you have a very strong business case for expanding now, you could try seeking alternative types of funding.

  • Cut regular outgoings so that you have more cash available to service repayments
  • Offer business or personal assets as collateral for your loan
  • Reduce the amount of working capital you have tied up in excess stock
  • End relationships with consistently late-paying clients to reduce your debtor days.

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