Business Loans 101

Access to finance is one of the top concerns of business owners.  Even profitable businesses can go bust simply because they can't fund their growth. As a business there are a number of options available in the market and each serve a different purpose.

Types of Business Finance

Your small business finance options include;

  • Overdrafts
  • Term Loans
  • Chattel Mortgages
  • Leases
  • Family, Friends and Fools!

Overdrafts

Everyone knows what these are.  Ongoing facilities that you can draw on and repay when cash comes in.  As long as the amount drawn doesn't go above your facility limit you don't even need to make any payments of interest - they just get capitalised into the loan.  These are the ultimate in flexibility and are great for funding your working capital requirements - those times when you just want to fund the difference between outlaying cash - for things like wages - and getting cash in from your sales.

Overdrafts can be secured against real property to get lower interest rates, or can be unsecured (no property security).  Both serve their purpose.

Given the the amount of flexibility and the lender needing provide certain amounts of capital on their balance sheet to meet their lending standards - the interest rates for these facilities will be "high".

But the important thing here is that overdraft's aren't really designed to be fully drawn at all times.  One week you might be $15k in overdraft, the next week it's all paid back - so that "high" interest rate is only applied for 7 days on the amount drawn. So your effective interest rate is likely to be much lower.

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Term Loans

Term loans have the same structure as your home loan.  You borrow a certain amount of money for a certain period and make principal and interest repayments over that term.  

Term Loans in business world can be for things like;

1. Buying your own commercial property

2. Buying a business

3. Investing in longer term projects (like starting a new marketing strategy involving many pieces like CRM, website etc)

Term loans can have fixed or variable interest rates, and in some cases (with some lenders like ANZ) can have terms as long as 30 years (where secured against appropriate security).

Chattel Mortgages

Ok, Chattel Mortgages are actually a type of term loan, but they deserve their own category given how much they are used.

As the name suggest's this is a mortgage - meaning that the lender is registering a security interest over an asset.  In this case the "chattel".

Chattels are moveable property - like computers, trucks, cars - anything you'd think of as "plant & equipment".

Registering a security over these assets means that if you don't make your car repayment, the lender can repossess your car and sell it to pay off the loan (and then sue you for any shortfall).  

So if there is a second-hand market for the asset, chattel mortgages are generally available.  If the assets don't hold their value well you might struggle to get a chattel mortgage because the lender can't or doesn't want the hassle of trying to sell a 2nd hand widget nobody wants.

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Chattel Mortgages terms are generally shorter; 3 - 7 years which matches the approximate useful life of the asset.  

The benefit of a chattel mortgage over a lease (discussed below), is that you are the legal owner of the asset once you sign the purchase contract - that means your business can claim the GST on that quarter's BAS, and you can claim the depreciation (currently all in the year of purchase).

Under a lease however you don't take ownership of the asset until the end of the term, usually for a nominal amount.  From a tax perspective this means you claim the GST on each lease payment over the term - so you don't get it all back in one go and there is no depreciation claim - rather you claim each payment as a tax deduction.

Over the course of term, chattel mortgages and leases give you the same tax outcome but chattel mortgages you just get it now, rather than over time.

Leases

Leases for small businesses are generally for things you don't want to use for long, or don't hold their value well.  It's common to have leases for hospitality equipment - like fridges, freezes, ovens, mixers.  This is because the 2nd hand price of these assets is minimal, the rate of business failure is high, and the lender doesn't want to have to try and sell fridges and freezers to get their money back.

They are also common for higher end cars - usually with repairs and maintenance all wrapped into one monthly payment - just watch the sting in the tail when the car gets older and the lease payment gets jacked up to cover the repairs and maintenance.

These leases are designed for people who want to roll over their car every 3 years. I'm not fan of this as you never end up owning anything and you're continually "renting" the asset.  The only people who make money out of cars are car dealers/manufacturers.

Family, Friends & Fools

These are all in the bucket of "private finance".  This could be from the bank of Mum & Dad, a draw down on the equity in your house, or someone you've convinced that you're onto the next big thing. 

Either way, these are generally a "term loan" - it just might be that the interest rate is very low (nil), and that the repayment terms are.....fluid.

My advice is that whenever you're mixing business and family or friends you document what the arrangement is.  That way everyone is on the same page and knows what the deal is. 

As accredited commercial brokers we can help with all types of business finance options (just not the fool part!) so whether you're looking for some new equipment, to buy your own businesses premises or just need some working capital get in touch and let us help find you a solution.

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