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Growing up

When you want to expand your business, there are various funding options available. Gayle Bryant investigates.

 

If you are looking to expand your business, there are a number of options to consider. While day-to-day expenses can be covered with overdrafts and credit cards, growing your business tends to require more complex forms of funding.

Generally you will have to choose between debt or equity financing and each has its own pros and cons.

Peter Bobbin, tax partner with The Argyle Partnership says there are limited ways to finance a business expansion.

"If you're lucky you can do it through retained profits in the company," he says. "But where there is not enough funds, you need to borrow money or get equity by bringing on new shareholders."

Different ways to finance through debt

Typically, a business owner of a small- to medium-sized enterprise (SME) first considers a loan when they need extra funds. However, there are a range of debt financing solutions that should also be considered.

These options include debtor financing. Under this facility, the bank advances the customer funds against approved trade invoices. When the invoices are paid to the bank, the bank then pays the customer the remaining invoice balance, less a fee for the service.

The benefit of this financing option is that, as your business grows (and therefore as your debtors' book grows), so too can your facility. The product is suited to businesses that have customers who regularly purchase significant value of products or services from your business.

Debtor financing is also known as cash-flow finance or invoice discounting. It tends to attract slightly higher interest rates than business loans secured by property but allows you to borrow more against your invoices. This system of financing is becoming very popular among SMEs, especially among those with a fluctuating cash flow. It means they don't have to wait for invoices to be paid to receive cash.

Depending on your business, debtor financing can be a great alternative to an overdraft and can be used in conjunction with other finance facilities for facilitating growth or business expansion, like term loans, commercial bills or asset finance as it generally leaves your assets available to be used as security for these lending types.

Should you mortgage the family home?

NAB's Head of Business Lending, Rob Elliot says one of the most common ways of expanding for SMEs is to borrow against the family home.

"The family home is an asset that is built up over time so you need to be very careful before you take out a mortgage over it to help fund a business," he says. "There is a lot at stake, especially if the business has not been well thought out and fails."

Bobbin says the first place to go for extra funds is usually the financiers, such as banks. "The advantage of going to a bank is that your business plan will probably receive the greatest scrutiny," Bobbin says. "Although with the proliferation of mortgage lenders, some of this conservatism has gone."

When it comes to receiving advice on funding options, Bobbin says there are many places to go to for advice including bankers, private equity investors or accountants and lawyers. "If you are finding it difficult to get finance and then a financial institution offers you a loan at a very high rate, you may want to think about the reason for this," he says. "It may mean the financier is nervous about your business because it is viewed as quite risky."

He adds that while it might be tempting to take the first finance your business is offered to expand, exploring your other options is wise. It does pay to invest the extra time in understanding your financial options to ensure you get the right product and the best deal for your business.

Elliot agrees that typically the bank is the first place to go for money. "There are many competitive products on offer," he says. NAB offers an extensive suite of business loan products that can be tailored to meet your individual needs.

You might also consider asset finance products. These products frequently use the asset itself as the security, freeing up your properties to be used as security for other growth lending as required.

Different loans target businesses that are at particular stages of their growth and expansion cycles and are designed to suit the individual requirements of those stages. For example, the NAB Business Option Combination Loan provides business finance that starts with an interest-only repayment period that is followed by a principal and repayment period aligned to a business' cash flow.

"So if you are establishing a business or expanding your business then the NAB Business Options Combination Loan is an ideal solution as it allows you to match your loan repayments to match your business' anticipated cashflow," Elliot says.

Consider financing with equity

Equity finance is usually most important at either the very early stages of a business growth cycle or at key stages of expansion. It can be sourced through friends, family, employees, business angels or the private equity market.

Inviting an employee to have an equity stake has a number of advantages including the fact they already know and understand the business and don't need to spend time learning about it. While you may be giving up an equity stake, the intellectual property they have in the business can make it a shrewd move.

Business angels provide start-up capital to young companies usually seeking less than $1 million. Often angels also provide advice based on their own business experience which is invaluable to expanding organisations.

Private equity or venture capital are funds provided by companies that invest for a share of business profits or a stake in the company. Investors tend to expect higher returns because their investment is at risk of poor performance by the business.

Bobbin says while equity finance is useful if you need funds, when you introduce equity, then you are giving away a part of the pie.

"Equity finance is more secure than debt finance as someone else is putting their money into the business but they are also taking equity out by being given a part of it," Bobbin says. "They might only take 25% but may demand that no decision about the business is made without them – so they have a controlling power even if they don't own very much."

Bobbin says therefore this type of funding can be expensive from the point of view of a loss of control but, on the other hand, new investors may be able to introduce a financial discipline that didn't exist before and that can benefit the business – especially if they already understand the business, such as a former employee.

"Whatever your financing needs, says Bobbin, make sure you have a good business plan to present to the bank."

More information on equity financing can be found on websites such as www.businessangels.com.au and the Australian Private Equity and Venture Capital Association (www.avcal.com.au).

Gayle Bryant is a business and finance writer who contributes to The Aust