Rewards & Risks for Both Business Lenders and Borrowers

Business Funding Options Explained

The type of business lending facility you choose can have a big impact on your business. In this blog post, we'll explore the different types of business lending facilities available, and help you choose the best one for your business.

There are various forms of lending facility, and the facility selected should be appropriate to the borrower’s requirements and circumstances.

Lending to businesses takes one of three general forms:

• a bank overdraft.
• a revolving line of credit, often known as a revolving credit facility.
• a term loan or commercial mortgage.

Each form of lending has its own advantages and disadvantages, so it’s important to choose the right one for your business. Let’s take a closer look at each:

Bank Overdraft

A bank overdraft is a temporary borrowing arrangement that allows you to dip into your account when you need to, up to an agreed limit. This can be a useful way to manage your cash flow, as you only pay interest on the money you use. However, an overdraft is a short-term solution, and you may be charged fees if you go over your limit. Additionally, your bank may call in your overdraft at any time, which could leave your business in a difficult financial position.

Summary: overdraft features

• A bank may agree to provide a customer with an overdraft facility, up to a stated amount (overdraft limit), for a stated period of time. The overdraft is repayable on demand.
• An overdraft facility may be renewed when it expires; there is no formal repayment plan.
• The facility operates through the borrower’s current account.
• An arrangement fee is normally charged by the lender on agreement of the overdraft facility, and then annually on renewal of the facility.
• Interest is charged on the daily overdrawn balance on the account.
• The rate of interest payable on an arranged overdraft is subject to negotiation between the parties, and it is usually set out in an overdraft facility letter from the bank to the customer.
• Interest is payable only on the overdraft balance, not on the total amount of the overdraft facility. A customer with an overdraft facility whose current account is in credit will therefore not pay any interest, so long as the account remains in credit.
• A customer may repay an overdraft without giving notice. This differs from a term loan, where the customer may terminate the loan early but usually only by giving notice to the bank, and possibly also on payment of a pre-payment fee.

Revolving Credit Facility

A revolving credit facility is a form of lending that allows you to borrow money up to an agreed limit, and then repay it over time, with interest. This can be a flexible way to manage your cash flow, as you can repay the loan as and when you have the money available. However, you may be charged fees for using the facility, and the interest rate may be higher than for other forms of lending. Additionally, the lender may reduce your credit limit at any time,which could leave your business in a difficult financial position.

A revolving credit is similar in many ways to a bank overdraft, but:

Revolving lines of credit may be provided to businesses to finance working capital. As a business spends and receives cash, its working capital fluctuates in amount and its net cash flows vary. As a result, its need to borrow changes continually.

Term Loan or Commercial Mortgage

- Term Loan

A term loan is a form of lending that allows you to borrow a lump sum of money over a fixed period of time, usually at a fixed interest rate. This can be a useful way to finance a major purchase or investment, as you know exactly how much you will need to repay each month. However, if you miss a payment, you may be charged fees, and your interest rate may increase. Additionally, the lender may require you to provide collateral, such as your home, to secure the loan.

- Commercial Mortgage

A commercial mortgage is a form of lending that allows you to borrow money to buy a commercial property. This can be a useful way to finance your business, as you can use the property as security for the loan. However, you may be charged fees for using the facility, and the interest rate may be higher than for other forms of lending. Additionally, the lender may require you to provide collateral, such as your home, to secure the loan.

Other options

Other lending options may be preferred in some situations. For SMEs, these options include asset leasing and factoring of trade receivables.

• Asset leasing

  a borrower (lessee) acquires the possession and use of an asset from a lender (lessor) for an agreed period, often several years. A leased asset for a business is a fixed asset, such as a car or truck. The lessor is a finance company (perhaps a subsidiary company of a bank), another finance leasing company, or the manufacturer of the leased asset. The lessee has possession and use of the asset but makes regular payments to the lessor, who remains the legal owner of the asset (although the lessee may have an option to purchase the asset at the end of the lease term). Asset leasing therefore involves acquiring and using a fixed asset without purchasing it, but instead making a series of payments to the lessor over the term of the lease agreement.
  
  

• Factoring (or invoice discounting) of trade receivables:

  a specialist debt-factoring company (which may be a subsidiary company of a bank) takes over collection of the trade receivables for a client and lends money to the client against the security of future cash income from eventual receipt of payments by the client’s credit customers. Factoring is a specialist form of secured financing of working capital (trade receivables). With invoice discounting, the borrower retains the responsibility of collecting the monies due from their customer.

Purpose of security

A decision to lend to a business customer should be based on the borrower’s expected ability to repay out of the net cash inflows from business operations. Security should not be seen as the probable source of repayment (unless sale of that asset is the means of repayment, such as a property bridging loan).

Which Lending Facility is Right for Your Business?

The right lending facility for your business will depend on your individual circumstances. If you need a short-term solution to manage your cash flow, an overdraft or revolving credit facility may be the right choice. However, if you are looking to finance a major purchase or investment, a term loan or commercial mortgage may be a better option. Be sure to speak to GIC Capital advisers to discuss your options and find the right solution for your business.

Finance is needed for working capital because a business must incur and pay for expenditures before it receives money from sales to customers.

Ask these six questions to every small business accountant you are considering.