How To Decide Between Debt and Equity Financing

small business loans article

Deciding on whether to go with debt financing or equity financing can be a pivotal decision that could change the course of your business’ future.

For small businesses in Singapore, 2018 is looking to be a good time to amass funds for company expansion. The overall economic outlook in Singapore is looking to be gaining traction, corporate tax rates are still steady, and the government is pushing for institutional lenders to make financing more accessible to SMEs.

When raising funds, it is imperative that all SME owners should decide on what the type of business financing that is appropriate. Options are usually narrowed down to either debt financing or equity financing.

Unsecured Business Loans for Most Businesses

Amongst many assessment factors, here are a few major factors that most institutional lenders look at when deciding whether to lend money to a company – revenue, assets, creditworthiness and cash flow.

Revenue refers to the total amount of income into the business on a year to year basis. In Singapore, a relatively healthy SME is deemed as having a revenue of at least $300,000 per year.

Assets refers to anything that can be used as collateral to secure a loan. Types of assets that can be used as collateral in Singapore are usually property, equipment, or anything that can be easily liquidated.

Creditworthiness generally refers to the company director’s personal credit history and/or the past payment history of any debt that the company has raised before.

Cash flow is possibly the most essential component when it comes to credit assessments. It typically looks at the debt ratio of a company, where revenue is taken against the total debt of the company. A reasonable debt ratio is 1.2 to 1.3 where revenue should always be more than debt.

For companies that are able to fulfill the above criterion, most institutional lenders are always willing to lend as they will have confidence in the ability of the borrowing entity to repay the business loan.

Invoice financing and other business financing options
For companies that are not strong with the main 4 factors, but happen to have receivables from reputable companies, invoice financing may be a viable option. Invoice financing is the process of raising funds by selling off accounts receivables to a third party financier.

The cost of invoice factoring can be a little bit higher than the cost of traditional unsecured business loans, but can be a sensible choice if incoming revenues are able to repay the cost of the debt. Invoice financing terms usually last from 30 – 120 days. Credit assessments for invoice factoring typically look at 2 things — 1) the reputation and credibility of the debtor, and 2) the credit worthiness of the borrower.

Many new businesses assume that they are not able to raise debt to grow their business. However, if properly explored, there are a few good options out there. An option in Singapore could be the SME micro loan, which is relatively easy to qualify for. It is limited to a maximum of $100,000, but can still be very useful for new companies. There are also a few private financiers who are willing to lend on a shorter term basis, ranging from 6 – 12 months, at rates that are significantly higher than the traditional banks.

If all else fails, business owners can also look into taking up personal loans for their business. It can be a good option of the business owner who have a healthy personal credit history. Interest rates may be a little bit higher than the average business loan from the bank, but repayment terms can be more flexible. Personal loan amounts can also be higher than a business loan if the business owner has a strong credit history.

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