One of the hardest aspects for businesses looking for funding is the ability to compare all of today’s options in an effective manner.
More and more products are entering the marketplace, and there is some real variety in how they are structured. It's therefore important to know how to analyse and compare.
Below are my top tips for comparing different finance options:
Compare products against a raft of criteria
It is not effective enough to compare only the headline interest rates and choose what looks like the cheapest option. For one, you will find many lenders “hide” parts of their interest in other parts of their fee structure, which we will come on to. Besides that, there are a number of different factors that may lead you to a completely different option, once you have all the facts.
I would suggest setting up a spreadsheet, and comparing each funder on the following criteria:
Control over the business
Some business finance options will give you the funds and it's then up to you what you do with it. Other funders will require some control over either transactions or incoming future funds to pay the loan. Different borrowers have differing views on this, so make sure it's an area you have analysed, asked about, and have decided upon.
This is critical. In particular, do they have experience of lending funds to businesses in your sector, and can they prove it? It is clear that some funders are getting involved in sectors that they have little experience in, and as a result take an increasingly conservative approach to lending or building the relationship. You will find that in certain instances, the less experience they have, the higher the rate they charge will be, and vice versa. A funder who understands your sector and its potential challenges if well worth working with.
Add up and compare the real cost of finance
The headline interest rate is just that; a headline. It does not tell you the full story. Ensure you get a full understanding of all the other fees including entry/arrangement, debenture fees, admin fees, disbursements, site visits charges, exit fees, any other ongoing maintenance of the facility, any potential penalties, how much those penalties are and when they might occur. Also check for any extra fees for paying off the facility early. Then you have the true cost of finance and can compare like for like.
Is the arrangement fee included or paid separately?
Some firms do not charge arrangement fees, but many do (of course check the total cost of finance to see whether the firm charging the arrangement fee is in fact cheaper than the one who is not charging!). If they do charge, find out if the arrangement fee needs to be paid by you on completion of the loan, or can be funded out of the loan facility (i.e. you don’t pay for it from your own pocket prior to the facility draw down). If it needs to be paid by you, of course check that you have it! Some businesses do not equate what the % amount will be as the monetary amount, and then find they do not have the actual funds up front to proceed.
How is the loan paid back?
This is extremely important as it can greatly affect cash flow. A wholesaler for example might find a slightly cheaper product needs monthly servicing, or a slightly more expensive product that can be paid back in full at the end of a short-term transaction period. Sometimes the more expensive, but more flexible product is better for the business as it significantly helps cash flow during that period. So the question to ask is: does your loan debt require servicing regularly or can it all be paid off at the end of the term?
Is the facility Pay-as-you-go or continuous?
Again this is another interesting aspect of comparing facilities that can greatly affect a business’ cash flow. Seasonal businesses for example may only need funding for parts of the year, and makes no sense to take on a longer term continuous facility that requires servicing in the quieter months. Interestingly, the “headline rate” of the Pay As You Go facility might be higher than the continuous option, but due to the short-term requirement for funding, ends up being cheaper when compared over a longer period. Yet another reason for delving deeper into structure as it can provide a surprising conclusion.
Is Interest charged on the facility or what’s been drawn down?
Another major question to ask is what the interest rate is applied to. Is the rate applied to the total facility amount, or on the amount that has been drawn down? I’ve written extensively on this, particularly where the headline rate is monthly. The number one point is that annualising the headline rate when that rate is applied to how much has been drawn down gives you the wrong figure. Put another way, you cannot multiply that rate by 12 and get the actual APR. The good news is that you can calculate an annualised rate, and it is usually much lower than the perceived APR.
What’s extra security does the lender require?
A full run down on what they require is also an essential early question to ask. Most will take a debenture, but not all. Many now will take Personal Guarantees, but they may be unsupported, limited, or fully supported. It’s important to be sure and comfortable with what they see as your commitment to the process. Do note that for most funders this area is non-negotiable.
The Default procedure
No one wants to talk about this, but as with any good contractual negotiation, it’s important to ask the lender what the process will be if something goes wrong, in case it does.
Typically there is a lot of comfort to take from asking about this process. Firstly, you will find that most funders will try to work with you in a positive manner should you potentially run into trouble. All they ask is that you communicate regularly, and tell the truth. If you are upfront about any troubles, then as long as the funder has prior knowledge, they typically take a supportive view to restructuring the debt.
Funders, remember, only make money when you’re in business and paying! It is costly to default a business, repossess it, and end the loan early. So a lender wants to give a business every chance to sort a situation out. What displeases lenders is hiding the facts or general dishonesty about what is going on. It is in these cases that action is usually significant.
As a footnote, asking about the default process, and many of the above questions, demonstrates a solid skill set to the lender. It shows them you take the process seriously, and will encourage them to lend.
Get all the facts before committing
In summary then, make sure you are evaluating your lending options on the fullest possible set of comparison criteria, rather than purely the headline interest rate. Once you know which funding options your business qualifies for, it’s then important to discuss in-house, and with your broker, which type of funding suits your purposes best. In the final analysis, you may well find that your preferred option was not the most obvious option at the outset.
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About Chris Davidson
Chris Davidson is Managing Director of Discover & Invest Ltd.
He believes passionately in providing businesses with market-leading financial insights that have a positive impact on the bottom line. As a result, Chris helps get the best rates and terms available at any one time.