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Different Types of Loans for Small Businesses

Business loans for business owners are more common than most people would think. If you are a small business owner, you often do not have sufficient finance in personal savings available to fund the growth of a business venture.

This is where business loans can help secure funding to grow your business. If you are a small business owner seeking a loan in Australia, you are not alone and there are many different types of loans such as motor vehicle loan, unsecured business loans, short-term business loan, invoice factoring and many more.

According to comparisons website CANSTAR, 1 in 3 business owners expect to need a loan for more than $100k but still less than $250k, and more than 1 in 10 business owners comparing loans are looking for a loan of up to $1 million or more.

A small to medium business could require financial assistance for a number of reasons, including:

  • Product development
  • Marketing
  • Staffing
  • Lease agreements
  • New technology and innovation

There are a number of options available to help take your business to the next level or to help it get through a rough patch. To decide on the right type of business loan it is prudent to answer these crucial questions:

  1. How much money do you need?
  2. What do you need the money for?
  3. How quickly do you need the money?
  4. How long will it take you to pay it back?
  5. How much collateral do you have to put up for the loan?

Once these questions have been answered, it’s time to take a look at the options available according to your unique business situation.

A Business Overdraft

A business overdraft is a facility attached to a bank account. An overdraft occurs when you make a transaction for an amount greater than the balance in your account. The bank then extends credit up to a maximum overdraft limit and you can make withdrawals up to that limit. Interest is charged on the fluctuating daily balance, but the overdraft balance does not need to be repaid within a set timeframe. The timeframe for arranging an overdraft will vary, depending on the stage of readiness of the business and the size of the facility.

Advantages

  • Suitable for short-term borrowing needs
  • Generally easy and quick to arrange, with immediate access to funds once the facility has been agreed
  • There is usually no charge for clearing the overdraft earlier than expected
  • Interest is paid only on the overdrawn balance
  • Funding is not dependent on giving up a share of the business
  • Interest and arrangement fees are normally tax deductible

Disadvantages

  • As with other types of debt, if the overdraft is secured and the business fails to repay, the lender may take action to seize the security provided for the facility.
  • Failure to pay the interest charges or go back into credit on a regular basis can lead to a fall in credit score, increased interest rates for existing and future borrowing, collateral being seized and legal proceedings against the company. Company directors may also be personally affected, depending on how the facility was structured.

 

Bank Loans

Bank loans are one of the most common forms of finance for small and medium-sized businesses. They are provided at a cost, which is the interest on the owed amount. Other fees and charges may apply, depending on the type of loan and on the lender. Interest is charged and will vary depending on risk of default. The most common types of interest rate will be fixed or variable.

Advantages

  • The loan amount, length of term, repayment schedules and type of interest rate can be tailored to suit the business, including both cash flow and income generation.
  • Interest and arrangement fees are normally tax deductible
  • Making timely loan repayments may improve the business’s credit score.

Disadvantages

  • Not as flexible as short-term solutions, such as an overdraft. For example, if the loan is repaid early, additional fees may be applicable.
  • As with other types of debt, if the loan is secured and the business fails to repay, the lender may take action to seize the security provided for the loan
  • A loan is not flexible and may not provide the best use of capital for businesses with fluctuating finance requirements
  • Defaults on loan repayments can lead to a fall in credit score, increased interest rates for existing and future loans, collateral being seized and legal proceedings against the company.

Credit Card

The most common form is the corporate credit card, which is very similar to the personal credit card; purchases are made on credit guaranteed by the card-issuing bank, while the cardholder is given a grace period to pay the issuer the balance spent. If used sensibly, business credit cards help bridge short-term funding gaps and manage expenditure.

Advantages

  • Easy to monitor and manage expenses of employees.
  • Reduces the need to keep petty cash.

Disadvantages

  • Unsuitable for long-term borrowing due to high levels of interest.
  • Potential for fraud

Peer2Peer

Peer2Peer lending is a relatively new option for businesses, where a company such as SocietyOne or BigStone act as a facilitator between individual borrowers and investors. The Peer2Peer lending companies charge a fee to act as the facilitator of the loan and simply connect individuals or businesses in need of a loan to potential investors. Investors can offer secured or unsecured loans with varying loan terms, depending on the constraints decided on by the facilitating company.
Advantages

  • The interest rates can be lower compared to traditional banks
  • The terms can be more flexible
  • Faster loan approval

Disadvantages

  • Finding an investor to put up the loan amount is not guaranteed
  • There is a limit on the amount that can be borrowed via a P2P platform

Angel Investor

A business angel is a wealthy individual willing to take the risk of investing in SMEs. One limitation is that these individuals are not common and are very often quite particular about what they are prepared to invest in. Once a business angel is interested they can become very useful to the SMB, as they will often have great business acumen themselves and are likely to have many useful contacts.

Family and Friends

This is potentially a very good source of finance because these investors may be willing to accept a lower return than many other investors as their motivation to invest is not purely financial. The key limitation is that, for most of us, the finance that we can raise personally, and from friends and family, is somewhat limited. Further to this point, if loans are not paid back on time to friends and family, it has the potential sour the relationship.