If you’re starting or expanding your business you may need to obtain finance.
Carefully consider the type of finance as it could affect your tax obligations and cash flow.
Before sourcing finance:
- determine how much finance you will need
- develop a sound business plan
- consider the timeframe you will need to repay the loan
- determine your ability to repay the loan
TIP: Seek professional advice from your accountant or business adviser to help you make sound financial decisions.
Types of finance
Two of the main types of finance include:
- Debt finance – money borrowed from external lenders, such as a bank
- Equity finance – investing your own money, or funds from other stakeholders, in exchange for partial ownership.
It is possible to have both types of finance in your business.
- You retain full control of your business.
- The interest on the loan is tax deductable.
- The loan can be short or long term.
- The loan must be paid back within a fixed time period.
- Loan repayments will commence shortly after the loan is approved.
- The loan is often secured against collateral which may include assets of the business or the owner’s property.
- It can be difficult to grow the business because of the cash drain of repaying the loan.
- Less risky than a loan as the investment does not need to be paid back immediately.
- You’ll have more cash on hand as profits do not have to be used to repay loan.
- The investor(s) can provide additional credibility and skill sets to your business.
- The investor(s) will want some ownership or controlling interest of your business and will have a say in business decisions.
- It takes time and effort to find the right investor for your business.
TIP: You are recommended to review the relationship with your lender on an annual basis to ensure that you are getting the best finance terms.
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Sources of finances
The main sources of debt finance are:
- Financial institutions - banks, credit unions and building societies. Finance can be provided as loans, overdrafts and lines of credit.
- Retailers –purchasing goods for your business through store credit via a finance company. Store cards can attract high interest rates; however some retailers offer an interest free period.
- Finance companies – most finance companies offer finance products via a retailer. Financial companies must be registered with the Australian Securities and Investments Commission (ASIC).
- Suppliers – trade credit allows you to delay payment for goods.
- Factor companies – also referred to as debtors finance. Factoring is when a business sells its accounts receivable (invoices) to a third party (called a factor) so that it can receive cash without waiting the 30 or 60 days for customer payment. Customers pay their invoice directly to the factor company. The cost for providing this service will vary between companies and it is important for you to research these costs before entering into any agreement.
- Invoice finance – essentially the same as factoring, however invoices are paid to your business and customers are not aware of your arrangements with the financier.
- Peer-to-peer lenders - matches people who have money to invest with people looking for a loan. Loans may need to be repaid within a certain time period and interest rates may vary according to the level of risk.
- Family or friends – may offer you money as a loan. To avoid misunderstanding it is important to have a formal written agreement specifying the terms of the loan, repayment requirements and terms of interest. Seek legal advice to draw up the loan agreement.
The main sources of equity finance are:
- Personal finances - self funding your business from personal savings or sale of personal assets.
- Venture capitalists – professional investors that invest large funds into businesses (as equity) with potential for high growth and profit.
- Family or friends – may provide funds in return for a share in your business or as a partnership. Carefully consider this option as a breakdown in business relationships may affect your personal relationships. Read Partners in Business for more information.
- Private investors – also known as ‘business angels’ are generally wealthy individuals who invest large sums of money in a business in return for equity and a share of the profits.
- Crowd funding – raising capital through the collective efforts of a large pool of individuals, primarily online via social media or crowd funding platforms. It allows investors to provide large sums of money in exchange for equity, or small amounts in return for a first-run product or other reward.
- Government – most government assistance for small business is in the form of free or low cost advisory services, information or guidance. However, you may be eligible for a grant in certain circumstances, such as business expansion, research and development, innovation or exporting.
- Stock market – raising money by issuing shares to the public. This can be complex and expensive, and poor market conditions may affect your ability to raise funds.
- The Australian Government provides a free online tool to find available grants and assistance. (Companies offering to find grants in return for a fee are usually using accessing information using this tool.)
- Learn more about managing and borrowing money at the MoneySmart website.
- Conduct a search for registered finance companies at the ASIC website.
- Compare financial products at the Canstar website.
- The Australian Private Equity and Venture Capital Association Limited can provide details for venture capital investors.