Last week I introduced you to the technical term for types of finance available to business – debt and equity. This article explores the different types of business loans (debt) available to start-ups. The main sources are:
Friends and family – This may be the only source of lending available to you, but make sure that they are aware of the risk and that they can potentially lose all their money. It’s better to put the agreement in writing and ensure they get independent advice on the risk involved.
Business contacts – It’s possible that someone you know and work with may be interested in investing and sharing the risk. Again, an agreement in writing is recommended.
Bank lending for start-ups –
Overdraft – This is the simplest form of bank finance. Basically, it is permission to have a minus or negative balance in your business banking account. The limit you can run to is agreed with the bank and you will be charged if you exceed this and/or may have transactions refused if it is exceeded. Overdrafts are repayable on demand and are expected to be cleared and stay cleared for at least 30 days during the year. They are usually more expensive than other loans, as the interest rate charged on the overdrawn balance is higher than a loan for a fixed period.
Term loan – This is a loan for a fixed period, usually at a variable rate of interest. Repayment will be calculated to repay the loan amount plus interest over the agreed period.
Long-term loans – These provide businesses with funding for periods from seven to ten years. They might be used to purchase large equipment items and repayments will be calculated to repay the borrowed amount plus interest over the agreed period of the loan.
Mortgages – These are usually used to business premises and may carry fixed or variable interest rates.
Leases – These are usually used to purchase equipment and require a minimum, up-front cost. The equipment is paid for on a monthly or quarterly basis and, at the end of the lease, you may be able to purchase the asset with a minimum payment.
Banks offer other funding options, such as invoke discounting etc, but these are largely unavailable to start-ups as the business does not have an established track record of trading. Other financing options will be explored next week.