When it comes to four-letter words, there’s plenty you wouldn’t say in polite company. But despite the sometimes-negative connotations, ‘debt’ is a four-letter word you shouldn’t be afraid to use. Especially when funding a small business.
From bank loans to asset finance, here’s what you need to know about different types of debt finance, applying for debt finance, and using debt finance responsibly.
What is debt finance?
Debt finance. The name makes it sound like a reckless way to fund a small business. No one likes the idea of getting into debt. But don’t let the terminology put you off. It’s actually one of the most common ways to start - or scale - a small business.
You might be familiar with some sources of debt finance - like business loans - but others might be new to you - like asset or invoice finance.
Debt finance just means you’ve borrowed money. Your mortgage and car finance are examples of debt finance - and they’re perfectly respectable and acceptable. So using debt finance to get your small business off the ground shouldn’t feel frightening.
So long as you borrow responsibly - and can repay what you’ve borrowed - debt finance can unlock the next level of your business’s potential and profitability. Here at Crunch we are proud to provide specialist small business accounting support, so read on to explore your options.
Types of debt finance for small businesses
High street banks
From personal savings to mortgages, high street banks have the lion’s share of our financial custom. So when looking for business finance, it’s natural that high street lenders would spring to mind. They’re a tried-and-trusted source of business funding, especially for established businesses and limited companies.
However, thanks to strict lending criteria, new businesses and sole traders may find their application on the reject pile through no fault of their own. Luckily, there are other options available to you.
Start Up Loans
Like the name suggests, a Start Up Loan is a loan for anyone looking to start or grow a new business (in the UK). They’re Government-backed personal loans that are available to businesses from pre-launch up to two years of trading.
The loan is unsecured, which means you don’t need any assets or guarantors to support an application. And all owners or partners in a business can individually apply for up to £25,000 each, up to a maximum of £100,000 per business.
In addition to finance, successful applicants receive 12-months of free mentoring to put them on the path to profitability. Find out more at Transmit Start-Ups.
Alternative lenders also provide a viable alternative to the high street banks. This can be beneficial for businesses that don’t fit traditional lenders’ narrow eligibility criteria.
One example is peer-to-peer lending, which matches up individual investors with businesses that need funding. Read more about alternative lenders in our article XXXXXXXXXX
Asset finance works two ways - either borrowing money to buy business assets or using your business assets as security for a loan.
If you need to purchase assets - like machinery or vehicles - for your business, you can use asset finance (often known as hire purchase). You don’t technically own the assets until you have paid for them in full.
You can also release cash against the value of your assets. You borrow money against the value of a machine you already own (or a percentage of it) and the finance company will use the machine as security.
They’re both a strong way to move your business forward, providing you keep up repayments. If you don’t, the finance company will take the assets off you to get their money back. So think carefully before applying for this type of debt finance.
This is a method of debt-based finance in which an invoice finance provider (sometimes called a ‘factoring’ provider) lends you money against the value of your unpaid sales invoices.
For example, if your unpaid sales invoices are worth £10,000, the finance company may advance you 90%, so £9,000. Your customers then pay 90% of their invoice to the finance company and 10% to you. The finance company will charge you a monthly fee for providing this service.
It’s a good way to free up cash if you need it fast though it may not be a suitable long-term strategy.
Business cash advances
These work in a similar way to invoice finance. But instead of being secured against actual invoices, it’s secured against future sales. This method is suitable for seasonal businesses that want to keep cash flowing throughout the year - particularly those that have high sales at certain times throughout the year (such as Christmas, summer or school holidays) but a lower level of sales at other times.
Applying for debt finance
Understand your options
Before you apply, think about the pros and cons of different forms of finance. Look at lenders’ repayment calculators - if available - so that you know exactly what your repayments could be. Consider what feels most comfortable and manageable for you.
Check your credit score
With debt finance, your credit profile may influence the lenders’ decision - particularly if you are a sole trader. So make sure you check your credit report before applying. This will help you understand how lenders see you and whether you’re likely to be successful.
Prepare to apply
The application process will look different, depending on which debt finance option you choose. Loans, for example, require you to provide a business plan and financial forecasts. Make sure you understand the application process and have time to prepare any paperwork you’ll need.
Using debt finance responsibly
The word ‘debt’ can have negative connotations. But borrowing money isn’t a bad thing at all so long as you borrow responsibly.
- Base your borrowing on a realistic appraisal of what you’ll be able to afford to repay
- Only borrow within your means - don’t ask for more than you can afford to pay back
- Make sure you can keep up with your repayments
- Don’t secure debt against something you can’t afford to lose - eg essential equipment that your business needs to function
And remember, if you are struggling with debt, you can contact National Debt Line
or Step Change for advice and support.
Ready to organise your finances? Contact Crunch expert accountants through our ‘Ask an Accountant’ service, or read some of our other helpful resources, including our guide on simplifying your small business accounting. Only £24.50 +VAT for Crunch Free members. Or, get unlimited access to an accountant through any Crunch paid subscription.