Whether you need a large lump sum to fund your expansion plans or regular access to credit to help you manage cash flow, being able to raise capital is key to business growth.
If you don’t have the resources to self-fund your business plans, you’ll need to look at third-party funding sources. That’s where business finance comes in.
Types of Business Finance
Business finance is an umbrella term that covers a wide range of financing solutions. The majority of these funding sources fall into two categories: debt finance and equity finance.
You may find that a combination of debt and equity finance can provide the short-term and long-term funding you need to accomplish your business goals.
What is Debt Finance?
Debt finance is a broad category that typically involves a lender providing funds that you later repay plus interest and fees. For traditional debt finance solutions like a bank loan, you will need to provide collateral to secure funding.
There are more flexible alternatives such as invoice finance that don’t require you to use your home as security.
Types of Debt Finance
There are a wide range of debt finance solutions that can be tailored to your business needs and circumstances.
Loans
Traditional loans are one of the most well-known forms of debt finance. You receive a lump sum from the lender and repay the principal plus interest and fees over the loan term. Loans are best used for significant business purchases and are usually only accessible to businesses with a long trading history and good credit rating.
Lines Of Credit
A line of credit is more flexible than a traditional business loan. The lender will set a credit limit that you can draw against as and when you need. You will usually be charged interest and a monthly fee for the facility. As you make repayments, the funds become available for use again.
For manufacturing and import/export businesses, a line of credit can sometimes be combined with an invoice finance facility to provide funding for cash flow gaps of up to 180 days.
Read more about Trade Finance Solutions.
Business Credit Cards
A business credit card works in the same way as a personal credit card. You apply for the card, and the lender sets a credit limit. You can use funds up to the credit limit and make monthly repayments on the principal and interest. Some card providers also charge a flat monthly or yearly fee.
Invoice Finance
Invoice finance is a flexible type of business finance that allows you to turn your accounts receivable into a source of fast funding. You can get an advance of up to 95% of your outstanding invoice value.
There are two main types of invoice finance: invoice discounting and factoring. In simple terms, discounting uses your unpaid invoices to access a revolving line of credit based on your outstanding invoices’ value.
Factoring works in a similar way, but the finance company takes over the collection of the unpaid invoice.
You can find out more about factoring and discounting in our blog post Invoice Discounting vs Factoring.
Invoice finance can be a good option if your business is cash hungry and has a lot of capital tied up in unpaid invoices.
Equipment Finance
If you are looking to purchase new or second-hand machinery or vehicles for your business, equipment finance can be an efficient way to spread the cost over a longer period. You can use the asset you intend to purchase as collateral for the finance.
An equipment finance facility usually involves the lender purchasing the asset for your business. You then make regular repayments on the principal and interest. Depending on the agreement’s terms, you may own the asset after your final payment, or you may be offered to buy the asset for a nominal fee.
Debt Finance Pros & Cons
Pro – Keep Full Control of Your Business
You don’t need to give up any equity or have anyone else involved in the decision making at your business. All profits generated are yours and don’t need to be shared with a third party.
Pro – Wide Range of Solutions
Debt finance can be beneficial at every stage of your business journey. You can secure a lump sum to fuel expansion or a flexible revolving line of credit to support working capital as you grow.
Pro – Tax-Deductible
The repayments on debt finance can be used as a deduction on your tax return to reduce your taxable income.
Pro – Easier to Access
In comparison to equity finance, debt finance solutions are much easier and faster to access.
Con – Hard to Qualify for a Business Loan
Banks have strict lending criteria that make traditional loans out of reach for many small businesses. According to the Reserve Bank of Australia, 90% of loans to SMEs are secured, compared to around two thirds of large business loans.
If you don’t qualify for a business loan, an invoice finance or equipment finance facility could provide the funding you need.
Con – Cost
There are always fees involved with debt finance. Even if your business has a long trading history and strong credit rating, you’ll need to pay interest and fees on the money borrowed.
Con – Restrictions on How You Can Spend the Money
If you qualify for a business loan, the lender may place restrictions on how you can spend the money. Invoice finance and other alternative debt finance solutions don’t impose these restrictions.
What is Equity Finance?
Equity finance is when you reach a funding agreement with a third-party investor, rather than a lender. In exchange for providing funding, the investor will take shares or part ownership in your business. As the company makes sales and brings in revenue, you will need to share your profits with the investor.
Types Of Equity Finance
While equity finance isn’t as varied and flexible as debt finance, there are several options you can pursue to raise capital.
Venture Capitalists
Venture capitalists are investment companies willing to provide funding for equity in growing companies that can deliver high returns. Most venture capitalists look for innovative startups that have the potential to disrupt an industry or become a nationwide business.
On average, venture capitalists invest $7M in a company. For the majority of small to mid-sized businesses, this type of finance is very hard to access.
Angel Investors
Angel investors have some similarities to venture capitalists. Both are willing to invest in growing businesses in exchange for equity. The main differences are that angel investors tend to work alone and use their own money to fund their investments.
The amount they are willing to invest is much lower than venture capitalists on average. To find an angel investor, you need to put together a detailed business plan and network to find high net worth individuals willing to invest in your business.
Crowdfunding
This form of equity finance has grown in popularity over the last decade. There are plenty of online platforms that allow businesses and potential investors to connect. Innovative startups and tech companies tend to do well with crowdfunding, with Oculus VR and MVMT Watches two noticeable examples of successful companies that started with crowdfunding investment.
As with all types of equity finance, you will need to exchange shares or part-ownership of your business.
Equity Finance Pros & Cons
Pro – Less Risk
The investor takes on most of the risk with equity finance. They will only receive a return on their investment when your business grows and generates more profit.
Pro – Less Initial Costs
There are no fees or interest payments with equity finance. You can invest the money into your business without worrying about paying it back. However, you will need to share your future profits with the investor.
Pro – Access Experience and Expertise
Finding the right investor can provide much more than capital investment. You can leverage their industry knowledge, connections, and experience to fast track your business growth.
Con – Shared Profits and Ownership
When you give away shares or part-ownership in your business, you need to split your future profits and surrender some of your control over decision making.
Con – Hard to Find
It can be very challenging for the average business to find an investor. You’ll need to prepare a detailed business plan and pitch, and be willing to look for potential investors continuously. If you need a short-term cash flow solution, debt finance is a much more suitable option.
Which Type of Business Finance is Right for Your Business?
If you need to raise capital urgently, debt finance is much more accessible. You can be approved for an invoice finance facility and receive a cash advance in as little as 24 hours. Depending on your credit rating and trading history, a traditional business loan or equipment finance can be a good solution for your long-term funding needs.
Generally, equity finance is a long-term funding solution that is harder to access. Be prepared for a long process of finding the right people to invest in your business. If you plan to grow to a national level and you’re willing to share ownership and profits, equity finance may be a good option.
ScotPac Business Finance
As with any business decision, it’s always a good idea to explore your different options before committing to a financing solution. Here at ScotPac, we offer a range of debt finance solutions to help you access the fund you need.
Every business is different, and we’re here to guide you through your options and find the best solution for you. Give us a call and speak to one of our business finance experts today.