An investment in knowledge pays the best interest | Short-term or long-term financing your business effectively
When it comes to running a small business, there is so much business owners need to know and do. From developing and growing the business’ offerings; building and maintaining client relationships; marketing; growing the team, and managing cash flow. The list goes on, and all the balls are in the air, almost all of the time.
When it comes to managing all the things there is a lot to be said about outsourcing (and you can read more on our thoughts on how to outsource with ease here). But there is only so much a small business owner can outsource, and when it comes to managing cash flow and considering finance options, this is usually something that stays with the business owner – with, of course, the support of a good accountant and some consulting from a small business lawyer (read more here on small business consulting from a lawyer’s perspective).
When you are considering financing for your small business you need to consider your options in terms of both short-term and long-term financing options. You will often hear us say ‘start with the end in mind’ and always be crystal clear on your exit strategy. When it comes to financing options, not only do you need to do your due diligence on the terms of your finance options (and work with your financial adviser or accountant on this), but as a starting point you need to be clear on the following:
what do you want to achieve with the additional funding (is the need for an immediate cash flow injection, or does it relate to longer-term growth?);
what are you committing to in terms of repayments, interest, and additional costs;
what are the security requirements of the funding (is the funding going to be secured over assets, and are you required to provide a personal guarantee?);
what will constitute a default and what additional interest and charges will apply if an event of default applies, and what the early payment options are (if any);
is early repayment an option?
So what is the difference between short-term and long-term financing for small businesses?
Short-term financing is generally used when businesses want to finance working capital, or want an additional source of funds to pay suppliers or increase inventory. Some common short-term financing options include short-term loans, a bank overdraft, or a line of credit.
Long-term financing, on the other hand, is used when the focus is achieving an overall improvement of the business and this forms part of a longer-term growth strategy. Some long-term financing options include issuing equity in the business, venture funding, or issuing bonds.
How to decide on the best option?
When deciding on which option is right for your business, the overall business plan and strategy need to be clear. The purpose and time period of the funds will be a key factor in deciding what option suits your needs, as a short-term need can be met generally through borrowing at a lower rate of interest and thus less overall costs. A long-term business expansion plan should not be financed by a bank overdraft which will need to be repaid in the short term.
The risk of the options you are considering also needs to be considered, as well as the exit strategy. A small business owner will want to maintain control over their business, so issuing shares and diluting ownership may not be a suitable option, whereas an overdraft or line of credit may be all that is required.
Being crystal clear on the objective and what you want to achieve with the funding is critical. We all know that positive cash flow is the cornerstone for every small business, so when it comes to keeping a positive cash flow in your business, careful consideration of the costs of different funding options and the costs of utilising the funds is critical. The business needs to be able to repay the principal sum plus the interest, and it needs to be able to cash flow these payments whilst maintaining a positive cash flow for the operations of the business.
Like all things in business, you need to understand what you are signing up for when you are securing a finance option. This is where an Australian business lawyer can help because you should always obtain legal advice on your obligations before committing to funding. You need to be sure the documents are in order and you need to be sure you understand all of your obligations when things are going as planned, as well as if something unexpected happens. Be clear on your exit strategy from the beginning so you are positioning your business for long-term success. You might also find our Beginners Handbook useful, it’s a wonderful reference tool that’s built to help you.
If you have questions about your legal obligations in respect of new or existing finance terms, or if you want to dive in and develop a strategy for moving your business forward, you can book a 1:1 Strategy Session with us here.
