Sometimes SMEs could do with a fast cash injection to help them cover the cost of a new asset or a cashflow shortfall. While debt might seem like a huge responsibility, it can be a useful tool for business growth.
What is debt funding?
Debt funding, sometimes known as debt finance, involves borrowing money from a lender to be repaid at a later date. It’s the opposite of equity financing, in which a company raises money from investors who are entitled to a share of its profits in return. Mortgages and credit cards are both forms of debt financing.
The primary advantage of debt financing is that you retain complete control over your business, which isn’t the case when you’ve got investors to answer to. It’s also easy to forecast expenses because loan payments are consistent and predictable.
Businesses might seek out large amounts of long-term debt funding when they want to purchase a new piece of equipment or machinery. However, they might also look for a short-term loan to help them out of a difficult spot, such as a cash flow shortfall.
Types of debt funding include asset-based lending, business loans, invoice finance, overdrafts, peer-to-peer lending and start-up loans. The UK’s major high street banks have traditionally been the go-to lenders for SMEs seeking asset finance. However, modern entrepreneurs are increasingly turning to specialist asset finance providers and peer-to-peer finance sites to meet their funding needs, according to the British Business Bank.
Why is it important to make your business attractive for debt funding?
Regardless of which institution you turn to for debt finance, a prospective lender will want proof that you’re likely to repay a loan. If you and your business seem credit-worthy, you’re more likely to secure a loan at a favourable interest rate on favourable terms.
How to make your business attractive to lenders
It’s not difficult to look like a good lending prospect – you just have to show that you’re financially responsible and that your business is in good shape.
High street banks will want to make sure you meet certain criteria from the get-go. They usually assess:
- The company’s credit history and the credit scores of its directors
- The business’s turnover (£100,000 or more is preferred)
- Transaction history and historic profitability
Would-be borrowers should remember that their personal financial histories will be under scrutiny when they apply for a loan. It’s a good idea to check your credit score and make sure you – and not just your business – appear trustworthy and consistent in repaying your debts.
You should also be able to show that a loan is an affordable long-term commitment for your business. Most funders will think of requests for funding that exceed a quarter of annual revenues as unaffordable. If you do want to apply for additional finance, you should be prepared to provide security for the loan. This means that you pledge a valuable asset – either yours or your business’s – as collateral.
It’s also important that you have a realistic, yet ambitious, growth strategy for your company and are able to demonstrate thoughtful forward planning. You should arrive at a meeting with a potential lender armed with cash flow projections and financial plans to show that you’re thinking pragmatically about your prospects. Lenders will want to know that your business has a solid track record and that it’s sustainable over the period of your loan.
Ultimately, good record keeping is crucial to ensuring you look like a good prospect for debt finance. Company directors must be meticulous in tracking costs and revenue, especially in the early days of operation. SMEs and startups should invest in accounting tools which are user-friendly and simple to update. That way, when it comes time to prove yourself to lenders, it’s clear that you’re ready to take on the burden of debt.[article id=”127492″ title=”SME Debt Funding Guide”]