Ravi Chandran
Getting the right business finance is essential for the success of every enterprise
By: Nesa Rahmat/
Getting the right business finance is essential. Investment, bank finance and other forms of funding can help successful businesses grow, while viable businesses can be destroyed by cashflow shortages. You need to decide which kinds of financing best suit your business and understand the implications of any financing agreement.
The right business finance puts your enterprise on a firm financial footing, reducing risks and increasing financial returns.
Your business plan
Your business plan and financial forecasts are the first step to successfully right business finance. Together, they help you assess your financial requirements and identify the most suitable mix of different kinds of finance. Preparing a range of forecasts based on different assumptions allows you to assess the risks and identify the need for contingency funding in case the business does not perform as well as you hope.
High-risk businesses generally require a relatively high level of equity finance: for example, your own investment in the company’s shares. Businesses that produce predictable amounts of surplus cashflow can afford to have a higher proportion of loans and other forms of bank finance.
A convincing business plan is also a key tool in persuading investors and lenders to support you. Lenders want to be sure that your business is a good risk and will be able to meet interest payments and capital repayments. Investors want to know how and when they can expect to realise their investment gains.
Equity investment
Equity investment provides the core funding for most businesses. Banks and other lenders will be reluctant to provide financing unless there is a cushion of equity finance.
Business owners, family and friends are often the first source of equity funding, particularly for small businesses without a track record. External sources of investment include so-called business angels, wealthy individuals who typically invest amounts from £50,000 upwards for a share of the business. Professional venture capital investors operate in a similar way but on a larger scale.
For the business owner, selling part of the company to raise equity finance can be a difficult decision. External investors look for the prospect of substantial returns, and will rarely value your business as highly as you do. Bringing in investors may also involve some loss of control, though the terms of the investment can be tailored to address this issue.
Bank loans and other debt finance
A bank overdraft is a simple and flexible way of providing day-to-day working capital. Alternatives such as factoring and invoice discounting offer funding that automatically increases as your sales grow, together with extra credit control and debt collection services.
A bank loan is generally a right business finance for medium-term funding needs. Loans may charge a fixed or floating interest rate, and can be tailored to match the life of an asset – such as the equipment you are acquiring – and your cashflow forecasts. Commercial mortgages can be used for premises, while lease finance can be a cost-effective way of funding purchases of equipment and vehicles.
A bank will generally require some form of security before providing financing. A typical small business loan, for example, will require a charge over the company’s assets. The bank might also want the company’s owners or directors to provide personal guarantees – putting personal assets at risk if the business fails.
You may want to check whether you qualify for a business grant. Business grants typically come in the form of subsidised loans towards the cost of a project that offers wider benefits, such as increasing employment especially in this Covid-19 crisis.
Generally, getting the right business finance will require that you raise all the money you need, plus a cushion – depending on what sort of business it is, 10-25% of the total. If you attempt to go back to your bank (or to investors) too soon, they are likely to assume that you have run through the original funding more rapidly than was projected, and have not begun to generate income to sustain the business. None of this is going to encourage them to make more cash available.
Knowing what is the right business finance would require you to know the difference between a term loan and an overdraft. A term loan is the loan of a fixed sum over a fixed period of time, with regular payments of interest and repayments of capital. Both the interest payments and the capital repayments may be postponed over a given period – for example, the first year of the loan – but once they begin they have to be maintained. Providing that the payments are maintained, the bank is legally committed to letting the loan run for the full period – it cannot be called in early.
An overdraft is a much more flexible arrangement on both sides. You will be given an overdraft limit on your business account and may borrow up to that limit at any time while it remains in force. However, the bank is entitled to withdraw your overdraft facilities without notice, which means that you could find yourself required to refund these borrowings on demand.
Banks tend to think of term loans as a method of financing specific investments, whereas overdrafts are intended to cover fluctuations in working capital.
So, what happens if you cannot keep up the instalments on a term loan? As soon as you see yourself heading into difficulty, speak to your bank and give a coherent explanation of how the problems have arisen. Banks are willing to listen, especially in this pandemic.
