Need Debt Financing ? Put These Basic Facts Ahead of You.

Your standard bank loan is the most obvious example.

This Page will explain to you the various forms of debt finance, how they differ in form and any basic pros and cons you may need to know about before committing your valued signature..

Friends and Family.

Some business owners raise funds through what is known asFriends and Family financing. Each of these deals is as varied as the relationship that underlies the parties involved.

Just remember – no matter what the relationship – be sure to treat your deal as a full-blown business contract –and not a casual handshake between brother and sister.

Put the amount of the loan and the terms of repayment in writing so that there can be no misunderstanding or confusion for any of the parties involved.

Its not unusual for close friends or relatives to fall out and end up in court.Some times calamities like death could bring third parties into an arrangement they were not conversant with, and only a written agreement would guide you.

Bank finance

After your own family, the most likely source of debt financing is the bank.

Short and Long term debt

A common form of short term debt facility available to business is called an overdraft. This is when the bank allows you to overdraw your account for a short negotiated period and at a pre determined charge.

Many businesses need overdraft finance from time to time. Overdrafts are useful for financing temporary — or fluctuating — cash shortages.

• You pay interest only on the amount by which you are overdrawn each day.


• Exceeding your overdraft limit is costly.
  The bank may bounce your cheques, damaging your credit with suppliers. You can also incur bank charges and higher interest rates.


• The bank could, in principle, demand repayment in full at any time, usually at 24 hours’ notice.


• Your overdraft limit is usually agreed for six to 12 months, after which it must be extended by negotiation. However, the limit can be reduced if the bank decides this is necessary.

Loan finance is often the best way to finance a longer-term business need.

• Most loans are for a fixed period of one to ten years. However, mortgages and some other loans may be for as long as 25 years.
• Repayment installments will be agreed in advance.
  Paying equal monthly installments of capital plus interest is a common choice.
  You may be able to arrange a repayment holiday to allow time for your cashflows to pick up before the first repayment is due.
• Loans are more suitable than overdrafts for longer-term debt financing. Both you and the bank make a commitment to the business, based on an understanding of your long-term plans and forecast cashflows.
  Your bank can advise you on what information is required and how figures should be presented when seeking a loan.

Bank-finance costs can vary widely.

• The interest rate for both overdrafts and loans is usually set at a margin over the bank base rate, which can vary.
  Margins on loans are usually two per cent to six per cent, depending on how risky the bank thinks the loan is. Alternatively, the interest rate may be fixed (eg a flat-rate ten per cent).
• An arrangement fee is usually levied when an overdraft facility or loan is set up. Typically the fee is one to 1.25 per cent of the facility requested or it can even be lower depending on how you bargain with the bank, and how they perceive of your business risk.
• A renewal fee is sometimes charged when you seek to extend the overdraft facility.


• You may also incur costs of arranging security towards debt financing as outline below.

Security for your borrowings

For any borrowing you need to show that you can afford the capital and interest payments. In addition, a bank usually wants security to ensure the loan is repaid if things go wrong. There are a number of different possibilities:

A personal guarantee is a guarantee from an individual like your self.

• If supported by a legal charge over your personal assets, these assets (including your house) can be at risk if the guarantee is called upon.

A guarantee from a third party, who will be liable to pay the debt if your company defaults.

• Directors of limited companies are often asked to provide personal guarantees in case their company fails.


• Sole traders (and partners) are already personally liable for all business debts.

Another source of security towards debt financing may be the Small Firms Loan Guarantee.

• Start-up businesses which can’t provide enough security may be able to get a Small Firms Loan Guarantee which can be used to guarantee small to medium business loans .


• The scheme is run by the Small Business Services and usually focuses on start-up and younger businesses who have been trading for less than five years.


• Your annual turnover must satisfy the limit for small businesses (see local trade journal for limits).


• The easier option is to ask your bank manager whether you are eligible for a loan guarantee.

You may need to take out insurance that will pay out if you suffer an accident, sickness or death.

• This cover will also protect the bank in case you are unable to work or pay.

Finally, You should seriously consider how much you are prepared to risk on the business. Can you really afford to lose your home or savings?

Tips on Working with your bank

Before lending you any money the bank will want to see a viable business plan.

Once your business is operational, provide the bank with regular management information summarising sales, margins and costs(e.g on a monthly or quarterly basis).

• Draw up a table of figures comparing what you actually achieved with your budget and with the previous year.


• Add comments to explain any differences and mention key events you are expecting (eg an order you think you will win).

Warn the bank if you expect to run into any financial difficulties.

• Teach the bank to trust you, your data and your Judgement. Avoid surprises.

If you are hoping to shop around for sources of debt financing , get good professional advisers involved early on. You may also contact us, for online support.

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