3.1 Borrowing
When you decide to finance your venture with debt, where can you get access to loans to start and grow your business?
As you might expect, your best source is the bank where you are currently doing business. After all, it is in the business of making loans. You are a customer. As such, you are a known commodity – you pay your bills, you keep your account balance positive, you don’t bounce checks. Start where you’re known.
Nonetheless, the choice of the right bank can be challenging. It takes some time to find the right bank and establish a trusting business relationship with it (Blundel et al., 2017).
Usually, banks do not take a shareholding or have an interest in the business. Therefore, any capital needs to be repaid after a contractually agreed duration, and interest is charged either at a variable rate (base rate plus a fixed amount) or a fixed rate.
It is important to remember that the bank assesses the risk and their return when calculating rates and each bank will have different policies on this. Banks will normally charge a fee for arranging financing and annually for agreeing overdrafts.
Generally, we distinguish between unsecured and secured borrowing. Credit card debt is a widely used form of unsecured borrowing. Although it is more expensive than other formal borrowing, credit card debt is very popular among entrepreneurs. This is because a credit card is easier to use and to get access to than bank borrowing. A credit card can streamline payments and is an anonymous form of funding that does not require any explanation to the lender.
Trading activities are often funded by an overdraft linked to a current bank account. Using an overdraft means borrowing at a variable interest rate, with a limit that is typically agreed each year and for an arrangement fee. This flexible type of unsecured borrowing is suitable for day-to-day expenses, but it can lead to high fees if the overdraft limit is exceeded (Blundel et al., 2017).
Loans are a form of secured borrowing. The entrepreneur (i.e. the borrower) incurs a debt and must pay interest on that debt until it is repaid to the bank (i.e. the lender) within a given period. The interest serves as an incentive for the bank to provide the loan. Interest rates can be subject to change and renegotiation (Blundel et al., 2017).
3 Alternative sources of funding