Choosing the Right Financing for Your Business in Australia

Whether it's opening a small bakeshop or transforming an idea into a tech startup, it’s a dream to start a business and become your own boss. In fact, the Australian Bureau of Statistics reported that Australians who started their business went up by 7% in the first half of 2022 with sole proprietors gaining 12.7%. That’s quite promising, isn’t it?

The truth of the matter is that starting a business often requires a lot of time, effort, and more importantly - money. Even if you already hit the ground running, you will still need extra financial resources to overcome any business- or market-related obstacles especially when you want to achieve business growth and expansion. With that, your options are either to streamline your cash flow or to raise more capital.

Current Climate of Small Business Finance in Australia

Failure to raise enough capital is one of the reasons why there were 2,410 personal insolvencies, debt agreements, and bankruptcies in Australia in the third quarter of 2022. According to the Australian Financial Services Authority, about 35.7% of that involves businesses. Although the numbers are far lower than two years ago, business failure is still looming on the horizon even as economic and market conditions are easing towards pre-pandemic levels.

Australia’s current state of business finance has also seen promising trends with retail sales, business sentiment, wage price index, and lending rates starting to pick up. However, much work must be done as small businesses still face higher borrowing costs due to their financial risk. Although business lending defaults have decreased since 2020, the demand for financing has flatlined for small- and medium-sized enterprises as larger businesses saw a tremendous increase.

Financing Option Checklist

Before you start getting financing for your business, you may have to ask yourself these questions:

1. Are you funding a startup, a business acquisition, or a business expansion? Are you trying to solve some cash flow problems?

2. How much do you need? Borrowing too much may put you in a worse place than before you took out the loan.

3. Do you need short- or long-term financing?

4. How risky is your business? You can attract more lenders willing to give you access to more funding if you have a sound business growth plan. After all, small businesses have higher borrowing costs due to perceived risks.

5. What's your business and personal financial history? A good credit history will come a long way in raising much-needed business financing.

6. What will it cost you? There's no such thing as free lunch so any form of financing will mean interest payment to lenders and profit share with investors. Which one will cost you less?

At the end of the day, it’s all about asking yourself – is all the financing worth the return on your investments?

Debt vs Equity Financing

Business funding can be categorized into two – debt and equity financing. Each option has its own pros and cons so knowing what you're getting into will help you find what's best for your business in any given circumstance.

Debt Finance

Most business owners borrow money, in the form of bank loans, overdrafts, mortgages, and credit cards, which they pay back with interest within an agreed time.

Debt can be secured or unsecured. Secured debt has collateral, a valuable asset that will satisfy the loan in case of default or non-payment. Conversely, unsecured debt doesn't require collateral.

Business owners approach commercial banks and other lending institutions for short- and long-term loans.

For small businesses looking to make up for some cash flow issues or cover key business purchases, short-term loans are the ideal choice as these are easier to secure. Most short-term loans are low doc business loans, which means lenders do not require volumes of documents as proof of your borrowing capacity. However, interest rates for short-term loans are much higher than long-term loans. These loans are often used to finance current business activities and operations.

On the other hand, taking a long-term loan with its spread-out repayment schedule might be a sound choice for businesses not willing to take a short-term financial risk. But securing such loan is much more difficult for new businesses because they most long-term loans will come from more traditional financial institutions, such as banks. Long-term loans are often used to finance the acquisition and leasing of key business assets from equipment to office space.

Not sure how much you need? Try a business line of credit as it allows you to borrow funds at a predetermined limit and pay interest on the money you borrow.

Equity Finance

Another way of financing businesses is putting your or someone else’s money into your business. Unlike debt financing, people who invest in your business will get a significant stake and the profit it generates.

Apart from personal savings and private financing from family and friends, business owners can also obtain equity capital from angel investors, venture capitalists, incubators and accelerators, crowdfunding, public floats, and grants.

• Angel investors are high-net-worth individuals who provide financial backing for up-and-coming startups in exchange for ownership equity.

• Venture capitalists provide private equity financing to startups and emerging companies that have high growth potential.

• Incubators and accelerators not only provide venture capital financing, but they also help startups and individual entrepreneurs develop their businesses through mentorship, management training, upskilling, and office space to kickstart their ventures.

• Crowdfunding is an alternative form of financing that utilizes small amounts of capital from a large number of individuals to finance a new business venture.

• Public floats are portions of corporate shares that are in the hands of public investors as opposed to locked-in shares held by stockholders with controlling interests, governments, or other non-public entities.

• Grants or tax credits are financial assistance provided by federal and state governments for up-and-coming startups and emerging industries.

Comparison

To differentiate these two types of financing options for your business, it is important to understand which suits your needs and preferences by comparing these financing head-to-head according to these key areas:

Ownership - WINNER: Debt Finance

When it comes to ownership of the business, you are 100% in charge of your business through debt finance while you will be relinquishing some control of it (and the profits it generates) in equity finance.

Revenue - WINNER: Equity Finance

You can put your revenue into growing business when you get equity finance while you have to use some of it to pay back your loans in debt finance.

Application Process - WINNER: Debt Finance

There is a straightforward process in debt finance but may not be as speedy as you want it to be. However, you need to do a lot of pitches to venture capitalists and angel investors to get that equity funding, and oftentimes, you will need lawyers to help guide you through such a process.

Repayments - TIE

Depending on the type of loans you get in debt finance, you are expected to pay in fixed or variable amounts while you will expect to provide dividends or returns to your shareholders in equity finance.

Interest Rates - WINNER: Equity Finance

You will avoid this burden in equity finance. On the other hand, you are exposed to changing interest rates in debt finance depending on the market conditions and your level of business risk.

Security - WINNER: Equity Finance

You are spared from further financial risk in equity finance while you may have to mortgage your house to get big money in debt finance.

Business Failure - WINNER: Equity Finance

In equity finance, you spread the financial risk to your investors in exchange for a significant share of the business. However, the business owner is expected to assume the financial fallout of a business failure in debt finance.

Expectations - TIE

You have to meet certain expectations in both financing options – repaying the lenders in debt finance and assuring partners and investors that the business will make money for them in equity finance.

Exit Strategy - WINNER: Debt Finance

There is a way out of debt financing and that is paying your loans and debts. In equity finance, it is much more complicated as you have to deal with other shareholders for complete control and running of the business.

Reporting - WINNER: Debt Finance

There's no need to provide reports on debt financing. As you have shareholders in equity finance, you have to update them about the business activities and overall financial health regularly.

Extra Benefits - TIE

You can access other banking and credit services as well as insurance in debt finance while there is an opportunity to access valuable investor know-how and networks in equity finance.

Things to Consider Before Choosing Financing

It is difficult to secure debt finance as new businesses have to provide accurate financial records, projections, and comprehensive business plans. More importantly, you also need to generate significant funds to service repayments, fees, and interests. And if not your initial cash flow, expect these payments to add up during the lifespan of your loans and debts.

Worst-case scenario, you will end up giving valuable assets to the lender should you fail to make repayments. In the end, you’re risking short-term financial stability in debt finance in the hope of achieving business growth in the long run.

If you end up going for equity finance, you’re also giving up control of your business for immediate short-term financial stability. When you’re sharing business control with investors, they will have a say in how to run the business. When it comes to raising funds, you will be competing with other businesses from the same venture capitalists and angel investors.

Beyond Debt and Equity

Many Australian businesses are gaining new sources of non-traditional capital financing with the emergence of new lenders - private equity and non-bank finance.

If you think debt or equity finance is not the type of finance that best fits your business, you may have to consider the use of leasable assets for your business through an agreement between two parties that specifies terms and conditions for the use of a tangible resource like a building or equipment. By the time the lease ends, the assets are either returned to the owner, the lease is renewed, or the assets are purchased outright.

One advantage it has over the other financing options is that valuable funds are not tied up from purchasing assets. Unlike debt payments, lease payments often come at the beginning of the lease period thereby giving the business more time to generate funds for debt payments at the end of the debt period.

The Bottom Line

Every business will need access to some sort of financing at a particular stage in its life cycle, especially in times of uncertainty. Even if securing that much-needed capital can be a daunting task, more financing options have become available for business owners these days. Seek professional advice to help you decide what makes better financial sense to your business moving forward.

Want to get your business funded fast? Funding Link is committed to providing small to large businesses with flexible and fast funding solutions. Find out what your options are. Apply here now!