When you are starting a business, you need MONEY. When you are growing a business you need MONEY. Most businesses do not make it off the ground because of cash flow issues. They have no money to invest in their product/service. NOW, I know that financially smart people avoid debt and credit cards etc BUT when it comes to business, debt is your FRIEND.
Debt is cheaper than equity because the lender faces less risk than a shareholder would, and also because the debt interest is tax deductible in the UK (and most other countries too). Debt gives you the means to make a profit. Your profit pays off the debt AND reinvests in your business producing more profit. So, hopefully you can see how you should not be afraid of debt when it comes to your business. Let’s look at some different types of lending.
Line-of-credit loans: These are short-term loans. They allow you to access a specified amount of money that is deposited into your business account on an as-needed basis. You will only pay interest on the amount that is actually loaned to you. Line-of-credit loans can be used to buy inventory and pay operating costs for working capital, among other things, but usually not to buy real estate or equipment. For example, you have a line-of-credit loan of £3,000. You want to draw down £1,500 to purchase some fresh lobster for your restaurant. So, you provide your bank with evidence of the cost for the lobster and your bank, satisfied with your evidence, approves the the draw down of £1,500. You only pay interest on £1,500.
Overdrafts: Overdrafts are very flexible. They are easy to set up with your bank and you can usually pay back the overdraft, quickly and informally if your company can afford to do so. However, overdrafts are so informal that a bank can usually withdraw an overdraft facility at any time, which could leave a company in financial trouble. Overdrafts are good safety nets for if you come across unexpected liabilities. Every business should have one…in my opinion.
Revolving lines of credit: This loan offers you a certain amount of money in a specified period of time, and allows that certain amount of money to be borrowed again upon repayment within that specified period of time. For example, say you take out a one year loan of £50,000 on 1 January. You draw down the full amount of the loan on 2 January and subsequently pay off the full amount in May. You can then, if you wish, draw down the full amount of £50,000 again, at any time within the life of the loan. You can keep repaying and drawing down up to £50,000 until the end of the loan. This type of loan is great if you want to draw down monies on an as needed basis BUT you also want security that such monies will be available to you unlike with an overdraft or a line-of-credit. You will usually have to pay a commitment fee for the unused part of the loan. The commitment fee is generally specified as a fixed percentage of the unused loan amount.
Bullet loan: A bullet loan is a loan where a payment of the entire principal (fancy way of saying the “amount”) of the loan, is due at the end of the loan term. For example, if you take out a one year bullet loan of £50,000, the loan repayment is due at the end of that one year term, in one swift BULLET payment. Under these loans, you usually have to draw down the full amount of the loan immediately and you do not have the option of repaying it and drawing it down again. Interest can be paid periodically within the term of the loan OR it can be paid with the principal, in a bullet payment at the end of the term of the loan.
Angel investment: There is also the option of getting a loan from an angel investor. These investors are usually experienced entrepreneurs looking for the next big thing; they’re in it to win it. Therefore, angel investors typically demand three things: a) equity, b) a high return on investment and c) a well-defined five-year plan in return. If you want a better idea of angel investors, watch the BBC’s The Dragon’s Den.
So these are the ways in which you can assist cash flow for your business. These are very, very BASIC definitions and as always, lawyers are key in looking over the detail so that you are protected. Also, debt has its draw backs too, for example it shows up on your accounting books as a liability and it comes with unavoidable interest charges. There may also be restrictions imposed on your business whilst it is a borrower of a bank. For example, most banks will require a right to possess and sell your business property if you fail to pay back the loan, or to seize your inventory. Again, this is why you need a lawyer. Think about what type of debt your business needs at the moment and then ask your lawyer to look at your bank’s paper work.
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