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Law for Business

Knowhow - guidance - precedents

05 FEB 2013

Is borrowing from the banks right for your business?

Are the bank's lending?  Depends on who you ask: if it's the banks then the answer is ‘Yes'.  If it's the many small and medium-sized businesses then the response is often a resounding ‘No'.  The recent trend does however seem to suggest that banks are beginning to loosen the purse strings.  With a gradual, albeit slow, apparent movement by the banks to start lending, we consider the attractiveness of raising debt finance by small/medium sized businesses.

Debt-finance is essentially money which is borrowed to run a business either on a short-term or long-term basis, typically from banks and more often than not backed by some form of security.  The principal amount is repaid together with an agreed level of interest.  Although the term "debt-finance" can sound negative, many successful companies have some level of debt-finance on their balance sheet.

 Advantages of Debt Finance

  •  As opposed to bringing in a new equity investor, which means giving up some of the ownership of your business (and profits), with debt-finance you will retain ownership of your business. Your obligations will extend to the repayment of the amount of money borrowed and the agreed level of interest. Thereafter, you will have complete freedom to run the business as you choose.  
  • Other than for variable rate loans, the principal amount borrowed and the interest obligations are known fixed amounts which can be forecasted and planned for by the business. 
  • Debt-financing can often attract tax deductions and so can benefit your business. This means that it could shield part of your business income from taxes and lower your tax liability every year.

 Disadvantages of Debt Finance

  • The money borrowed plus the interest will need to be repaid even if your business is not successful, usually on fixed pre-agreed dates.  
  • Banks can often require personal guarantors to stand behind the obligations of the borrower, usually the directors/shareholders/partners of the business. Careful consideration of all the potential implications is critical before signing a personal guarantee.  
  • Having debt on your books will have a negative impact on your credit-rating, making future finance potentially more tricky. 
  • Given the cautious approach taken by banks, obtaining debt finance may prove difficult. Even if finance is available it may be too expensive due to high interest rates, or too onerous, due to the conditions placed on the business by the lender.

Debt-finance may be difficult to obtain for many businesses given the recent economic climate and the change in the attitude and requirements of the banks.  Nevertheless, it is an avenue well worth exploring and can provide your business with an effective source of finance to develop and expand your business without the need to bring in outside investors and give up a share of your company.

If you require legal advice on debt or equity finance, please contact Ashan Arif at aarif@clarkslegal.com or on 01189585321.

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