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Starting a small business is never easy. It takes hard work, investment, and significant effort. So, it is only natural that small business owners feel extremely proud when their new business is not only profitable but growing. Yet, a growing business comes with its challenges – one of them being, how should the business fund its growth in its early stages? Unless your business is doing exceptionally well, it may be difficult to fund your growth and expansion. This is especially the case if you are solely relying on your profits. This is where external funding comes in to add financial support. In this article, we discuss three funding sources you can use to fund your growing small business.

Business Term Loan  

A business term loan from a lender, like a bank, is perhaps the most common form of funding. It is also one of the most accessible to a small business. A business term loan is a cash advance provided by a lender to a business for a specific purpose for a specified period. This period is usually around three to five years. The full loan amount may be advanced to your business at the start of the term of the loan or be provided in instalments as agreed between your business and the lender. This will depend on the purpose of the loan.

Business term loans are well suited if you require a significant expense to grow your business. This includes acquiring a major asset or even another existing business. However, there will be eligibility criteria for any loan you apply for. Additionally, an important consideration for the lender before providing funding is whether the purpose of the loan will assist your business to generate enough revenue to repay the loan. Therefore, naturally, lenders are stringent that you use the loan for the specified purpose and nothing else. Not complying with this requirement will usually result in a default.

As a requirement for providing the business loan, the lender will also ask your business to provide security to support the loan. This may include a mortgage over land, like your residential property, or an interest over all your business’s property. The lender will have the right to deal with, or even sell, the security to satisfy the debt should your business default on the loan. For example, when a bank loans you money and you default, they will take on your security from you.   

Business Overdraft Loan

However, suppose funding your growing business does not involve acquiring a major asset or significant business spending. In this case, obtaining a business overdraft loan may be a good option for you. Business overdraft loans are usually offered by banks and are revolving loans attached to a bank account. You can draw money up to the loan limit. You can also repay or redraw the money at any time during the loan term. Unlike a business term loan, banks tend to permit you to draw funds for any business purpose. Businesses generally use it as short-term finance to meet their working capital needs when there is a shortfall in cash flow. 

For example, if you are a manufacturer who has completed a large order for a client, you may experience a shortfall in cash flow until you receive the payment from your client. A business overdraft loan allows you to draw funds and continue meeting orders from other clients while you await payment for your large order. 

One of the most attractive features of a business overdraft loan is that you generally only pay interest on the amount you have drawn. This is unlike a business term loan, where you are paying interest on the full loan amount. This makes a business overdraft loan a better financing option where you are not sure of the exact amount you will need over a period to fund your growing business.  

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Factoring

Like a business overdraft loan, factoring is a suitable financing option to increase your cash flow. Factoring involves a lender (called a factor) buying a debt a customer owes your business before that customer must pay the invoice. The factor usually pays a proportion of the invoice amount (usually around 80%) after the invoice is issued to your customer and the factor is satisfied with the debt. The factor will usually require your customer to pay the invoice amount into the factor’s bank account. Once your customer pays the invoice amount to the nominated bank account, the factor pays you the remaining invoice amount, minus the factor’s fees. 

This type of financing has various benefits. These include allowing your business to have immediate access to cash instead of waiting for your customer to pay and outsourcing the debt collection component of your business, leaving you to focus on growing your business. In addition, most factors in the Australian market are private lenders. This means they generally require less collateral and paperwork to approve funding compared to traditional lenders like a bank. 

Key Takeaways

If your small business is growing, you may need external financing to assist with that growth. While a business term loan is great where growing your business requires acquiring a major asset, options like a business overdraft loan and factoring may be better if you need more cash flow. You should select a type of financing that will assist your business reach the highest potential.  If you are in the process of obtaining finance for your small business and need legal assistance, you should contact LegalVision’s banking and finance lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

I want to purchase a major asset for my business. Which type of funding is right for me?

We would recommend a business term loan in this case. They are better suited towards significant expenses like major assets. However, the answer will depend on exactly what you need the funding for and your business’ unique situation, and external factors like interest rates.

I need short-term cash flow for my business. What type of funding is right for me?

If you need short-term cash flow, factoring and business overdraft loans may help. These types of funding provide immediate access to smaller amounts of money. They both have different features, so ensure you select the right one for your business.

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