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Debt finance is a critical and often misunderstood funding need. For many SMEs it is the primary catalyst that enables growth and business expansion. In the UK there are several sources of debt funding, from traditional banks through to specialist debt funding.
For business owners looking to understand how debt finance can support their plans it is important to find and form a relationship with the right funder. The information on this page provides an outline and guidance on the debt investment landscape.
What is debt:
- Borrowing an amount that is paid back with interest by a future date
- Can be in the form of a secured or unsecured loan
- Often used for working capital or acquisitions
A popular funding option, debt finance is based on the underlying concept of a lender providing capital in exchange for repayments and interest until the principal loan is repaid after a specified amount of time. The capital is usually secured against the business or its assets, often in the form of a debenture.
Debt finance doesn’t typically require the business to relinquish any equity, which is an attractive feature for business owners looking to maintain control. Repayments can be structured based on the strategy of the business, making it an ideal option for businesses that may have lumpy or seasonal cash-flows intrinsic to their business models.
There are now a range of product options available spanning traditional loans, loans from challenger banks and more varied options such as asset-based finance offered by alternative lending companies. While traditionally, debt funding was perceived as having a difficult conversation with a bank manager, there are now a plethora of routes available as providers continue to make waves in this exciting marketplace.
Pros – why you should consider debt investment:
- Growing number of options available depending on the age, assets and ambitions of a business
- Business owners retain control and all aspects decision making
- Highly suitable for businesses with a strong balance sheet and a diverse client base
- Offers predictability for a business’ cash-flow, with repayment terms and interest set out from the outset
Disadvantages with debt finance, however, is that business security is likely to be needed, sometimes lenders will also look for personal guarantees from business owners or majority shareholders. Failure to keep up with repayments could result in the loss of assets. Despite their attempts at endearing themselves back to the British public and the corporate world in general, the banks remain at best reasonably consistent in their lending policies. Many are clearly looking to reduce exposure to the SME sector and it’s clear that credit functions are having an increasing influence over the discretion of front-line relationship bankers to lend.
Cons – things to think about:
- There will be a checklist of criteria a business will need to meet before being accepted
- Debt is often secured against assets which will be at risk if debt repayments fail
- Fixed terms mean a business must repay all debt and interest within a given timeframe
Business owners should look to explore their options and find a deal that suits them, firstly by examining the funder’s history and any additional support offered by them e.g. via public sector growth programmes and secondly for the interest rates and terms of the contracts available. Debt funding has a higher level of structure than equity, such as the value and frequency of repayments and the fixed term length, all which will have an impact on a business’ bottom line in the years following investment.
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