Applying for Business Finance in Ireland
There are three main types of business finance:
Debt: The business borrows from an external source to meet its business needs (i.e. a business loan);
Equity: A private investor provides a cash injection in return for part of the ownership of the business to support its growth;
Cash: A business can also finance its growth through cash from the business owner, family or friends, or grants from government agencies.
Be clear with your finance company, and yourself.
- What is the purpose of the loan?
- What amount is required?
- For what period of time?
- How is the business contributing towards the financing?
- What will the repayment schedule be?
- Will the loan be secured on the asset being financed?
Types of Finance
There are several different types of finance. The type of finance you use will depend on whether it is for a short-term or a long-term use. The “golden rule” is to match the type of finance (short-term or long-term) to the intended business need (short-term or long-term).
Lending for short-term purposes adds to a business’s working capital. Three main types of working capital loans are:
- Invoice discounting
- Visa business cards
For long-term purposes, the most relevant forms of finance are:
- Asset finance (leasing and hire purchase arrangements)
- Term loans
Overdrafts are a short-term permission by a bank to a business. They allow the business to make payments or withdrawals on the business current account, up to a specified amount (overdraft limit). The amount of the overdraft used is subject to a daily interest charge. Generally, there will also be quarterly fees as well as an annual facility fee.
Businesses may use overdrafts to managing working capital and to meet a very short-term financial need.
Overdrafts are usually easy to arrange and they do not have a fixed repayment schedule. Interest is only charged on the amount of the overdraft that is actually used by the business.
However, an overdraft is a temporary source of finance, repayable on demand. The bank can demand repayment of the entire amount at any time, without explanation or notice. Banks will usually require customers to manage without the overdraft for a set number of days each year to prove that the overdraft is not a permanent source of finance.
If the business shows that it is using the overdraft on an ongoing basis, the bank may suggest that some or all of the overdraft be converted into a term loan.
This a form of business finance that provides ongoing working capital. The lender prepays a portion (usually 70%-85%) of the business’s accounts receivable (another name for trade debtors).
With this type of funding, cash flow is generated from actual, rather than future, sales. It is particularly suited to certain industry sectors (such as manufacturing) where the business concerned has a debtor book above a certain size, and where the sale is free of ongoing contractual obligations.
Typically, a lender will conduct an assessment of the quality of the debtor book and the suitability of the underlying transactions for invoice discounting. Assuming this is satisfactory, the lender then assesses the business’s background, management and financial performance. If approved, the lender will offer to lend the business an amount based on the eligible invoices issued by the business (up to 85% maximum). The business retains full control of the administration of the sales ledger and the relationship with the lender stays confidential.
The lender pays the business the difference between the amount received from customers and the amount advanced to the business (less any charges). More cash can then be raised as more invoices are issued. This provides a revolving (or ongoing top-up) loan to the business.
In a similar vein, but far less common in Ireland, is factoring. With factoring, the lender directly takes on the management of the sales ledger and the collection of money owed by customers. Factoring incurs higher fees because of the higher level of involvement by the lender.
Visa business cards
Visa business cards are an interest-free, short term, cashflow management tool offering you control, simplicity and certainty. They allow you to put your expenses on the business card on a monthly basis and not utilise their business’ cashflow for 37 days. There are no transaction fees when you use your credit card to pay for goods and services. This makes it a more cost-effective alternative.
This is a loan that is made by a bank to a customer. It is repaid in regular installments over a set period of time. Term loans usually last between one and ten years (three to five years is common). However they may last for longer periods if buying a commercial premises.
These types of loans are usually more suitable for longer term, larger purchases e.g. capital equipment or business premises. A commercial mortgage is a type of term loan, with a typical term of seven to 15 years. A commercial mortgage can be used to purchase a business premises.
Some of the main attractions of a term loan are the certainty that it provides to a business over its ability to finance itself into the future and the predictability of loan repayments. An overdraft would usually not be a suitable way of buying a long-term asset, as the bank could demand repayment at any time.
The length of the term loan is generally fixed from the outset. Repayments are increased or reduced to take account of variations in the interest rate. The interest rate on a term loan may be fixed or variable.
Asset finance is used to fund a wide range of moveable business plant and equipment e.g. machinery and transport vehicles. The bank buys the asset and leases it to the business wishing to use the asset, by way of a lease agreement. This lease agreement gives the business the use of the asset for a given period (usually 3-5 years). In return the business pays a monthly sum to the asset owner (the bank). At the end of the lease period, the business can either extend the lease by paying a small annual rental to the bank, it can trade the asset in, or the asset may be bought outright.
Leasing requires less additional security, because the loan is secured on the asset being financed. The asset cannot be recalled during the life of the agreement, provided the customer complies with the terms of the lease agreement.
Some equipment manufacturers provide leasing arrangements direct to customers. This is called vendor finance.
An additional form of asset finance is hire purchase. In this case, the bank buys the asset, and then hires it to the customer over an agreed term, normally 3-5 years. On completion of the agreed term, the customer may purchase the asset on payment of a nominal fee (called the purchase installment). Assets financed by hire purchase are accounted for as “owned” assets of the business. This can have useful tax benefits.
Goods that are leased or subject to a hire purchase agreement have important VAT differences.
VAT is payable on the rentals (lease amount) of the asset, not on the purchase price of the asset. You may be entitled to reclaim VAT on rental payments if you are a VAT-registered customer. However, this is not usually the case with motor vehicles, and then only in very restricted circumstances.
Businesses registered for VAT may reclaim the full VAT upfront on the assets/equipment. You can provide a copy of the hire purchase contract as evidence of purchase. Note that VAT is not normally recoverable on motor vehicles.
Check out your individual VAT position with your accountant before entering any arrangement.
Applying for a Loan
Depending on economic conditions, loan rates may vary significantly over the term of the loan. It is important to work out which type of interest rate suits you. For a fixed rate loans, check whether there are any charges if you repay the loan ahead of its scheduled repayment term. You may have to pay the bank’s financial costs associated with finishing the loan early.
Depending on the size of the loan, the bank may seek security to protect its position if the loan is not repaid in accordance with the agreed terms. Have you provided the right amount of financial information? Typically, depending on the loan amount sought, banks may require:
- Up-to-date financial and management accounts (typically the last six months)
- Debtor profile/listings
- Cashflow projections
- Confirmation of tax status
- Personal statement of affairs, covering the financial position of the owner
Have you demonstrated the business’s repayment capacity over the intended life of the loan?
Have you outlined possible stress scenarios that show how the business would fare under different assumptions? E.g. revenues grew by 15% less per year than assumed by the business projections.
Remember when Applying for Finance for your Business
- Demonstrate repayment capacity. Show the bank that the business will be able to repay the amount borrowed and to meet the associated interest payments.
- Prepare a business plan. This will help give the bank much of the assurance that it will be seeking about a business’s ability to repay a loan. Contact Anu Change to help you prepare and receive your Business Plan and Cashflow Templates.
- Account for security. You may need to provide some form of security in order to borrow the money. The directors or owners may be asked to give personal guarantees to the bank if the business is a limited company. Remember, you may need security for a bank loan.
Contact Anu Change for a free 30 minute Consultation from a Qualified Financial Advisor to help you source the right funding for your business.