News Article - Finding Finance

As every business knows, obtaining finance has become considerably more difficult in the last year.

The bank is often the first port of call for a new business or for a business seeking funds for expansion. Many businesses operate with an overdraft facility, but most do not appreciate – until it is too late - a vital distinction between overdrafts and loans: an overdraft is repayable on demand, whereas a loan is secure as long as the lender’s conditions are being complied with. Overdrafts are also renegotiated more frequently than loans (which generally stay in place for the full term), giving the bank more opportunities to revise the cost of the facility. In good times an overdraft is more flexible than a loan but when times are tough, it may leave the business more exposed if, for example, the bank decides unilaterally to reduce the facility.

In the current economic climate it is crucial to ensure that bank covenants – the conditions placed on the facility – are complied with. Any failure may give the bank an opportunity to withdraw the facility or alter its cost. If there is any risk of failing to meet the conditions imposed on the facility it is better to warn the bank before the conditions are breached than to wait for it to happen. Maintaining a good and open relationship with the bank – one in which there are no surprises – is more important than ever.

Banks are not the only sources of finance. Many businesses are looking to alternative sources of commercial finance, such as leasing and hire purchase for the acquisition of assets and to factoring or invoice discounting to ease day to day cash flow by advancing the receipt of sales cash. For significant injections of funding, the venture capital market could be considered, but the returns currently required by venture capitalists can be considerable and it is likely that they will also want a significant say in the way the business is run.

In seeking long term finance a distinction needs to be made between loans and equity. Loans will carry interest, which will impact on reported profits, but leave the business under the owner’s control. Equity – essentially shares – will not carry an interest charge (though issuing shares may lead to payment of dividends) but will potentially affect the degree of control the owner has. Shareholders cannot, however, call in their funds easily whereas lenders often can.

There are many factors – including flexibility, cost, timeframe and control - to consider in sourcing finance and choosing the right type of funding is more important than ever.

Written by Paul Aplin.  Paul is a tax partner with A C Mole & Sons and former Chairman of the Institute of Chartered Accountants in England & Wales Tax Faculty.