How to Finance Your Small Business?

By Ram - Apr 12 2024

Financing your dream of starting a small business to make a reality is at the top of every new business owner’s priority list. Continuity is always a concern for every business, no matter how long you have been in the industry.

Most Australian small businesses are family-owned and operated and often look to external loans and funding options to help get the business off the ground and improve cash flow.

While small businesses might not have as many funding options as large businesses, they still have plenty of options based on their type of business and industry. Understanding the complete list of financing options available to your business is crucial in ensuring you maximise your funding options and choose one with the best financing terms.

Overdrafts and Credit Cards 

Overdrafts and credit cards are short-term loans that provide immediate cash for everyday expenses. These are a good backup choice when you’re short on funds and, in many cases, don’t require additional authorisation. Some banks have overdrafts enabled automatically, which makes it easy to access the overdraft when you’re short on funds.

Overdraft interest is usually lower than credit card interest, mainly because the overdraft has some form of makeweight security behind it, whereas a credit card can be linked to business turnover.

When considering an overdraft, you should consider the following:

  • Has it been enabled automatically on your account?
  • What’s the limit on your overdraw? This limit differs depending on the bank and how much money you have in your account, or equity in assets
  • What are the interest rates on the overdraft facility, due dates and terms and conditions
  • Do you want the overdraft linked to your credit card?

Credit cards are also a short-term loan option for small businesses and provide immediate cash for small- to medium-sized expenses.

You can reserve credit cards for more considerable expenses because they come with higher interest rates than overdrafts.

The funds you get through the credit card have freedom of expenditure, meaning you can choose what you want to do with the funds.

The conditions of the credit card vary based on your usage and repayment capabilities. Some lenders offer credit cards with interest-free days, which are an excellent option if you know you can repay your credit fairly quickly.

Before settling on a credit card for small business financing, you should consider the following:

  • The number of credit cards you currently have and your ability to repay
  • Interest rates and rewards you might accrue on your card
  • A comparative cost analysis between the banks
  • Types of fees you might have to pay during the lifetime of your credit card

Debt Financing

Debt financing means borrowing money from external sources. It is one of the popular ways to finance your small business. The majority of new small businesses are funded with debt financing.

This financing method is usually through bank loans or bonds. Business loans are the first option most business owners consider, with most requiring that the loan be repaid within a certain period and with interest.

Most business loans require some sort of collateral that the bank can possess if you fail to make the payments on time. A professional business plan will assist lenders in better determining your financial situation. Still, the bottom line is that you or the business needs to have assets to take advantage of debt financing.

Benefits of Debt Financing

  • Access to capital: Debt financing allows small businesses to fund their operations, purchase equipment and expand without giving up equity in the business.
  • Tax deductible interest: The interest paid on business loans is tax deductible. It reduces the overall cost of borrowing for the business.
  • Business control: Debt financing doesn’t dilute the ownership or decision-making authority of the business.

Disadvantages of Debt Financing  

  • Repayment obligation: Borrowed funds must be repaid with interest, which can financially burden the business if it faces difficulties.
  • Interest costs: Accumulated interest can make the overall cost of borrowing higher than expected
  • Collateral requirements: Some small businesses might not have the assets to set up as collateral for funding.

Grants

Grants are non-repayable funds from government agencies, private institutions or non-profit organisations to support specific businesses or projects.

There are different grants designed to get your small business up and running. However, the applications for grants are notoriously long, and the competition is fierce. Considering you don’t have to worry about repaying the money or getting assets to set up as collateral, qualifying businesses should keenly consider this type of financing.

Benefits of Grants

  • Support for innovation: Some grants specifically support research and development, green initiatives and innovation.
  • Credibility: Receiving a grant can enhance a business’s reputation and attract even more potential investors.

Disadvantages of Grants  

  • Competitive application process: Grant applications can be highly competitive, with limited funds available for many applicants.
  • Stringent requirements: Grants have strict eligibility criteria and don’t cover businesses in certain fields. Your business must meet specific objectives or deliverables to be considered for the grant.
  • Limited use: The grants are for specific projects, limiting their application.

Angel Investors

Angel investors are another way for small businesses to get funding. These are investors seeking smaller, riskier deals in promising and emerging businesses. They contribute smaller amounts of capital than venture capital firms and are a more accessible funding source.

Angel investors go beyond securing financial support. It’s also an opportunity to foster a personal connection. They can also offer valuable business guidance and serve on the board, among other vital roles that might support the growth and success of the business.

However, the investors relinquish a portion of the business ownership in exchange for their support and investment. But on average, this is a smaller stake.

Conclusion

Small businesses can also use other financing methods such as crowdfunding, venture capitalism, strategic entity investors, and even sourcing from family and friends. Each of these financing methods has its benefits and downsides, and the business must understand these thoroughly before committing to any type of financing to avoid legal and ownership challenges in the future.

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