Short-term capital should not be used to fund long-term plans – and equally, long-term debt finance should not be chosen to meet short-term or immediate needs.
On the financing journey, it is highly likely that you will need both, and the task is to get the mix right. Debt will undoubtedly be involved in growing a business. Debt finance comes in many different forms, each of which can be more or less appropriate to the type of business, the stage it is at in its development or the plans it has to grow. And often an established company will use a blend of different debt products from a range of providers.
Debt can be used for longer-term investment and/or to fund working capital. For the former, a loan, bond or leasing arrangement can be more appropriate and for the latter, some form of overdraft or asset-based finance (ABF) is likely to be more appropriate.
At any stage of its development, a business is likely to need a mix of different forms of debt. All have their advantages for different aspects of a business’s growth plans.
Debt, in its simplest terms, is an arrangement between borrower and lender. A capital sum is borrowed from the lender on the condition that the amount borrowed is paid back in full either at a later date (a bullet repayment), multiple dates or over a period of time. Interest is accrued on the debt and the business’s repayment usually has an element of capital repayment and interest.
Unlike equity, debt does not involve relinquishing any share in ownership or control of a business. However, a lender is far less likely to help a business hone its strategy than a business angel or VC investor.
There are three broad categories of debt:
- loans and overdrafts
- finance secured on assets
- fixed-income debt securities.
Overdrafts or fixed-term loans constitute the most likely debt options offered by most banks or other lending institutions. You may also have been offered peer-to-peer (P2P) business loans and start-up loans.
Finance can be secured against your business assets. Secured debt options may include asset finance (leasing or hire purchase) and ABF (invoice discounting, factoring, asset-based lending (ABL) and supply chain finance). These are provided by most banks and specialist asset finance and ABF companies including some online platforms.
There are also community development finance institutions which provide micro-finance loans to start-ups and individuals as well as established enterprises. For further information visit the Finding Finance website.
Merchant cash advances are unsecured advances of cash, based upon future credit and debit card sales. These are repaid via a pre-agreed percentage of a business’s card transactions. If the cash advance takes longer to pay off, the originally agreed repayment cost remains the same.
What is most appropriate depends on the purpose of the capital being borrowed, the credit record of the borrower, the amount, the repayment term and the interest that is being repaid. You can see what is available from different providers on the Better Business Finance website.
To start your finance journey, use our interactive tool on this website.