Sources of finance: Debt vs. Equity finance
Before you decide on a finance option and visit a lender or investor, it's a good idea to see what's available. Two of the main types of finance available include:
- Debt finance - money provided by an external lender, such as a bank, building society or credit union.
- Equity finance - money sourced internally by the business.
Once you know how much finance you need, it's important to know your options. Knowing who to approach for finance can help you find the best finance option for your business. It can also give you several alternatives if traditional finance options fail. See the list below for some common sources of debt and equity finance:
Financial institutions such as banks, building societies and credit unions offer a range of finance products with both short and long-term finance solutions. Some products include business loans, lines of credit, overdraft facilities, invoice financing, equipment leases and asset financing.
If you require finance to purchase goods such as furniture, technology or equipment, many stores offer store credit through a finance company. Generally, this is a higher interest option and is suited to businesses that can pay the loan off quickly within the interest-free period.
Most suppliers offer trade credit that allow businesses to delay payment for goods. The terms often vary and trade credit may only be offered to businesses that have an established relationship with the supplier.
Most finance companies offer finance products via a retailer. Finance companies must be registered, so before you obtain finance check the Professional registers on the Australian Securities and Investments Commission (ASIC) website.
Factor companies offer a form of finance where they purchase a business' outstanding invoices at a discount. The factor company then chases up the debtors. While factoring is a way to get quick access to cash, it can be quite expensive compared to traditional financing options.
Family or friends
If a friend or relative offers you a loan that is expected to be repaid, it's called a debt finance arrangement. If you decide on this option, carefully consider how this arrangement could affect your relationship.
Often called 'bootstrapping', self funding is often the first step in seeking finance and involves funding purely through personal finances and revenue from the business. Investors and lenders will both expect some amount of self funding before they agree to offer you finance.
Family or friends
Offering a partnership or share in your business to family or friends in return for equity is often an easy way of obtaining finance. However, this option must be carefully considered to ensure your relationship is not adversely affected.
Investors can contribute funds to your business in return for a share in your profits and equity. Investors such as business angels can also work in the business providing expertise or advice as well as providing funds.
Venture capitalists are generally large corporations that invest large sums in start-up businesses with the potential for high growth and large profits. They typically require a large controlling share of the business and often provide management or industry expertise.
Also known as an Initial Public Offering (IPO), floating on the stock market involves publicly offering shares to raise capital. This can be a more expensive and complex option and carries the risk of not raising the funds needed due to poor market conditions.
In general, the government doesn't provide finance for starting up or buying a business. However, you may be eligible for a grant in certain circumstances, such as business expansion, research and development, innovation or exporting.
Some social media websites offer entrepreneurs a 'crowd funding' platform for their product prototypes or innovative projects. It involves setting a funding goal, providing project and budget details and inviting people to contribute to a startup capital pool.
What to do...
- Search our Grants & Assistance for details about government grants, incentives and other funding programs.
- Check the Professional registers for registered companies on the ASIC website.
- See the MoneySmart website for a list of Companies you should not deal with.
- If you've been treated unfairly by a finance provider, contact the Financial Ombudsman Service.
- Seek finances in your state or territory.
- For details about specific finance products, see Business finance products.
- See the Australian Stock Exchange website for details about listing.
- If you're thinking of investing in your own business and want to improve your personal finances, visit the MoneySmart website.
- See the MoneySmart website for more information on Crowd funding.
- Seek advice from a business adviser or accountant.