Starting a business is an exciting and challenging process. However, with many lenders requiring 2 years of financials and proof of profitability before they will approve a start-up business loan, it can be difficult to obtain the necessary finance for start-ups to get your business off the ground.
In this article, we’ll explore the different types of financing available to Australian startup businesses and what you’ll need to do to obtain a loan.
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Types of Financing Available to Startup Businesses
Unsecured Lending
Unsecured lending is an option once a business has been trading for at least three months. With unsecured lending, you can obtain a loan without any collateral. This type of financing is beneficial for startups that have a strong credit history and cash flow.
Unsecured overdrafts typically aren’t available until you’ve been trading with at least 6 months of positive cash flow history.
Equipment Finance
Equipment finance is an option available to startup businesses for purchasing assets to grow their business. This type of financing is ideal for startups that require equipment or machinery to produce goods or provide services. With equipment finance, the equipment itself is used as collateral, which makes it easier for startups to secure a loan and makes them a cheaper option to unsecured loans.
Invoice Finance
Invoice finance, also known as invoice factoring or debtor finance, is an option for startups from day one. Invoice financing allows startups to get paid immediately for the work they do, rather than waiting for the invoice to be paid in full. The benefit of this is the funds can be used for any legitimate business purpose including supporting your current work in progress.
Private Lending
Private lending is an option for those with equity in their property and is usually in the form of a first mortgage, a second mortgage or a caveat loan. This type of financing is ideal for startups that require a larger amount of capital and have assets to secure the loan. Private lending is unregulated and there are tremendous variations in the standards between lenders. Because of this we strongly advise getting expert advice before entering into private loan contracts.
Equity Release
Equity release is another option for startups that are beginning their business and already owning assets like vehicles, equipment or machinery. You could also release equity from your home or investment property by refinancing with a residential mortgage. The benefit of equity release loans is that rates are typically much cheaper than unsecured loans but they might take a week or more to process an application through a lender’s approval process to when funds are available in your account.
What You’ll Need to Obtain a Loan
To obtain a loan for your startup business, you will need to meet different requirements for different kinds of start up business loans. Below we’ve listed common features that will be considered in loan applications and which small business loans they may or, importantly, may not be required for:
Business Plan
Business Plans are not as commonly necessary to business lending as perhaps they once were. Whilst a business plan is not an essential component for some loan applications it could help with equipment finance for startups. If you need to provide a business plan as part of your application it should include details about your business, your background, your target market, products or services, marketing strategies, and financial projections. Your business plan should be clear, concise, and demonstrate a case for a lender to provide funding for successful business lending.
Director Credit Score
Your credit score is an important factor that lenders will consider when assessing your loan application. Your credit score is based on your credit history and indicates your ability to manage debt. You can obtain your credit score from a credit reporting agency like Equifax but know that lenders may be taking reports from many agencies. Private lenders typically don’t take into consideration your credit score as their assessment is based on asset values and having a plausible exit strategy.
Collateral
If you want the benefit of a lower rate that secured loans provide you’re going to need some kind of security. Commercial valuations, as distinct from the kind of valuation a home loan lender will undertake, can be required over residential property. If you’re raising capital against equipment the lender will require a valuation and inspection prior to settling the finance. Depending on the individual lender most will lend against the orderly liquidation value (OLV) and not the retail value if raising capital against machinery.
Cash Flow
Lenders will also consider your business cash flow and this will be a critical factor for many start-up business loan types. Unsecured loans are assessed by an analysis of bank transactions over a period of 6 or 12 months and increasingly equipment finance providers are using this style of assessment too.
The benefit of this kind of assessment is that it’s often completed by software which makes it extremely fast. The speed allows for credit decisions within hours and that means fast finance for startups. Private lenders will not typically assess business cash flow and rely on equity value and a sound exit strategy as talked about before.
Interest Rates and Loan Terms
Interest rates and loan terms are also important factors to consider when obtaining a loan and their outcome on repayments is inextricably linked. High interest rates translate to high cost but short loan terms mean higher repayments as you have to repay the loan faster than you would over a long term. High interest rates and short loan terms, as is the case with some unsecured loans, can wreak havoc on a business’s cash flow.
It’s important to remember that even if you have a profitable business, loan repayments will be paid from (and therefore take away from) future cash flow. Part of choosing the right loan for you is assessing if you can afford the repayments in the future.
Choosing the right lender – more important than you might think
Obtaining startup small business financing can be a challenging process, but it’s not impossible. Your solution for your small business financing will almost certainly lie outside of the major banks and with lenders that have purposefully created policy niches to support start-up loans for businesses.
If you need support to choose a lender that’s right for your startup business get in touch with an expert at Dark Horse Financial.
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