How debt structuring can be vital to business growth

By Altitude Advisory | June 20, 2022

Debt can be vital to helping you grow and protect your business.

Selecting the right debt structure is important, as it not only helps you manage the day to day running of your business, it also gives you flexibility when you need additional funds.

To help you understand the various types of debt finance options available, we have summarised them below including the pros and cons of each.

It is important to know that most debt facilities will require some form of security in case the borrower is unable to repay the debt. They will also have different interest rates depending on the type of security and the level of risk attached to the business or transaction.

Bank loans

Purpose: To fund various types of business transactions, including the purchase of another business or a long term asset such as a building. For established businesses with suitable security, a bank loan can be used to restructure short-term debt (e.g. a bank overdraft) into a cheaper longer term facility.
Security: It will generally be secured against a specific asset or assets (e.g. a building) or the business itself.
Borrowing term: Long term between 5 and 30 years.
Interest rate: Either fixed or variable.

Types of bank loans

Type	Structure
Term Loan	- Maximum fixed term - Fixed borrowing amount - Repayments can be interest only or principal and interest - Can be fixed or variable interest rates - Generally, cannot pay out early if on a fixed interest rate without penalty - Generally secured against a specific asset or assets or the business
Line of Credit	- Maximum fixed term - Flexible facility - Variable borrowing amount up to a maximum limit (i.e. you can drawdown and repay as working capital allows inside that limit) - Extremely useful for businesses that experience variability/seasonality in their operations - Capital repayments are variable - Interest repayments are made monthly - Generally variable interest rates (rates are normally higher than term loan due to flexible nature of facility) - Can pay out early without penalty - Generally secured against a specific asset or assets or the business
Bank Bill	- Generally shorter term facility but can be used for longer periods - Facility “rolls-over” on set periods (e.g. 30, 60, 90, 120, 150, 180 days) - Flexible facility - Capital repayments can be fixed or variable - Interest repayments are made monthly - Can be fixed or variable interest rates - Can pay out early without penalty - Generally secured against a specific asset or assets or the business

Equipment & asset finance

Purpose: To fund the acquisition of items such as vehicles, equipment and fit-outs.
Security: Secured against the asset being acquired.
Borrowing term: Short term between 1 and 7 years.
Interest rate: Usually fixed with monthly repayments.

Types of equipment and asset finance

Type	Structure
Hire Purchase	- Lender purchases asset and “rents” it to borrower until final instalment made - Ownership not transferred until instalments paid - Fixed borrowing amount - Can have a lump sum (balloon) payment at end of term - Repayments are principal and interest an agreed terms (e.g. monthly, quarterly, yearly) - Interest rates set at commencement of loan - Generally, cannot pay out early without penalty - Claim GST on each payment
Chattel Mortgage	- Borrower purchases asset and has ownership from commencement - Fixed borrowing amount - Can have a lump sum (balloon) payment at end of term - Repayments are principal and interest an agreed terms (e.g. monthly, quarterly, yearly) - Interest rates set at commencement of loan - Generally, cannot pay out early without penalty - Claim GST on upfront on purchase of asset
Lease	- Lender purchases asset and rents it to borrower until final instalment made - Lease must have a residual payment which when made triggers transfer of ownership of asset - Ownership not transferred until instalments paid - Can elect not to take ownership at completion of lease period - Fixed borrowing amount - Payments are characterised by regular rental payments on agreed terms (e.g. monthly, quarterly, yearly) - Claim GST on each payment

Working capital finance

Purpose: Various types of facilities to support the short term cash needs of a business.
Security: Secured or unsecured. For specific types of working capital finance (e.g. invoice or inventory funding), a security will be taken against a specific asset.
Borrowing term: Generally a more flexible finance period as they are ongoing facilities.
Interest rate: Either fixed or variable and in most cases the interest rate will be higher than a bank loan.

Types of working capital finance

Type	Structure
Overdraft	- Flexible facility - Variable borrowing amount up to a maximum limit (i.e. you can drawdown and repay as working capital allows inside that limit) - Extremely useful for businesses that experience variability/seasonality in their operations - No fixed capital repayments - Interest payments are made monthly based on daily facility balance - Generally variable interest rates (rates are normally higher than term loan due to flexible nature of facility) - Can pay out early without penalty - Can be secured of unsecured
Inventory/Stock Finance	- Variable facility that uses the inventory/stock of a business as direct security - Amount of facility will be a percentage of the value of inventory (normally between 50% and 80% of value) - Normally higher rate of interest due to risk - Facility paid down as inventory is sold - Good for growing businesses or businesses that carry a floorplan (e.g. vehicle or equipment dealers)
Invoice/Debtor Finance	- Variable facility that uses the debtors of a business as direct security - Amount of facility will be a percentage of the amount of invoices (normally up to approximately 85% of debtors balance) - Amount of drawdown will generally need to be repaid within 90 days of customer invoice - Normally higher rate of interest due to risk - Good for growing businesses - Higher maintenance and more complex facility requiring good administration systems - Normally unable to be accessed by businesses that issue progress payments (e.g. construction/building)
Trade Finance	- Provides a facility for businesses that are involved in importing or exporting - Fixed limit amount with no fixed term (similar to a line of credit) - For importers the facility provides working capital to assist purchase of inventory/stock where other facilities are not suitable - For exporters the facility provides working capital on invoicing where other facilities are not suitable - Normally higher rate of interest due to risk - Good for growing businesses - Higher maintenance and more complex facility requiring good administration systems
Credit Cards	- Flexible facility - Variable borrowing amount up to a maximum limit (i.e. you can spend as working capital allows inside that limit) - Unsecured facility with high interest rates and penalty rates for non-repayment - Can obtain interest free facilities subject to full repayment within guidelines - Drawn amount of facility should be repaid each month - Can pay out early without penalty - Generally an unsecured facility
Bank Guarantee	- Facility that supports an underlying claim or obligation to a third party (e.g. a supplier or a customer) - Examples to a supplier include property leases - Examples to customer include warranty/defects retentions - Will generally require a form of direct security

Alternate finance

Aside from the options listed above, the following alternate sources of funding are also available:

Types of alternate finance

Type	Structure
Vendor Finance	- Will occur where you purchase an asset (normally a business) from a third party - Lender will normally take secondary security over the business - Used where normal funding options cannot be accessed to fund 100% of the purchase - Normally higher interest rate
Peer to Peer Lending (Crowd Funding)	- Obtained through aggregators or direct third party (e.g. family) - Fixed borrowing amount - Expensive interest rates due to risk - Can be secured or unsecured - Normally a last resort option

All debt finance options have pros and cons, so it is critical that regular reviews of your funding mix are carried out so that your debt is correctly structured for your business.

Learn how we can support you in selecting the right debt structure to help your business grow and prosper.

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