Business funding options in Australia: debt, equity and everything between

Most businesses that run short of money do not have a funding problem so much as a matching problem. They use an overdraft to buy a building, sell a slice of the company to cover a seasonal cash dip, or take on a loan when the real issue is that customers pay too slowly. The right question is not "where can I get money?" but "what is this money for, and how will it be paid back?"

This article walks through the main ways Australian small and medium businesses raise funds, and how to think about which one fits.

Start with the purpose

First, be clear about three things:

• What the money will do. Fund working capital, buy an asset, buy another business, or cover losses while you grow.
• How long it is needed for. A few weeks, a few years, or permanently.
• Where repayment comes from. Future profits, the sale of stock, collection of debtors, or a future sale of the business.

A simple rule of thumb: match the life of the funding to the life of what it pays for. Short-term needs suit short-term funding; long-lived assets suit longer-term funding.

Debt: borrowing and repaying

Debt means you keep full ownership of the business, but you commit to repayments whether or not trading goes well. Interest on money borrowed for business purposes is generally deductible, which lowers its after-tax cost.

Term loans

A fixed amount borrowed over a set period, usually for a specific purpose such as fit-out, expansion or an acquisition. Banks will want to see that the business can service the repayments from its cash flow, and will usually ask for security, often including personal guarantees from directors. We cover what lenders look for in preparing a business loan application.

Overdrafts and lines of credit

Flexible facilities you draw on and repay as cash moves in and out. They suit timing gaps, such as paying suppliers before customers pay you. They do not suit permanent funding.

Asset and equipment finance

Vehicles, machinery and equipment can often be financed against the asset itself, through a chattel mortgage, finance lease or hire purchase arrangement. Because the asset is the security, this can be easier to obtain than an unsecured loan. The structure you choose affects GST and tax treatment, so get advice before signing.

Invoice finance

If customers take 30, 60 or 90 days to pay, a financier can advance a portion of outstanding invoices. It turns debtors into cash sooner, at a cost. Weigh it against simpler fixes, such as tightening payment terms.

Trade credit and supplier terms

Often overlooked, supplier terms are a form of funding. Negotiating 45 days instead of 14 can free up meaningful working capital without a lender involved.

Non-bank and online lenders

Non-bank lenders can be faster and more flexible, particularly for businesses with short trading histories. They are usually more expensive. Read the full cost, including fees, and understand what happens if a repayment is missed.

Equity: selling part of the business

Equity funding means bringing in someone who owns part of the business in exchange for capital. There are no fixed repayments, but you give up a share of future profits and some control.

Friends, family and existing shareholders

Often the first source of outside capital. Treat it as formally as any other investment: written terms, a clear valuation and an agreed understanding of what happens if things go badly. Informal arrangements cause more family and partnership disputes than almost anything else.

Angel investors and venture capital

Suited to businesses aiming for rapid growth and a sale or listing in the future. These investors expect a large return and usually want board representation, reporting rights and protections in the shareholders' agreement.

Private equity and strategic partners

For larger, profitable businesses, a private equity investor or a strategic partner in the same industry may take a minority or majority stake. This often forms part of a succession or growth plan.

Crowd-sourced funding

Australia has a regulated crowd-sourced equity funding regime that lets eligible companies raise money from the public through licensed intermediaries. It involves disclosure obligations and ongoing costs, and suits businesses with an engaged customer base.

Any offer of shares is subject to the Corporations Act fundraising rules. There are exemptions for small-scale and sophisticated-investor offers, but they have conditions, so get legal advice before approaching investors.

Everything between: hybrids

Some funding sits between debt and equity:

• Convertible notes. A loan that can convert into shares later, often at a discount, when a priced investment round happens.
• Vendor finance. When buying a business, the seller agrees to be paid part of the price over time. It shows the seller's confidence in the business and reduces the upfront cash needed. We often see it in entrepreneurship through acquisition deals.
• Earn-outs. Part of a purchase price depends on future performance, sharing risk between buyer and seller.
• Revenue-based finance. Repayments rise and fall with revenue. It can suit businesses with recurring income but tends to be expensive.

Grants and government support

Federal, state and territory governments run grant and support programs, often for research and development, exporting, regional investment or particular industries. Programs open and close frequently and usually have strict eligibility rules and reporting requirements. Treat a grant as a bonus to a sound plan, not the plan itself.

Choosing between them

A simple example: a business needs $300,000. If $200,000 is for new equipment and $100,000 is to cover slow-paying customers, the sensible answer might be equipment finance for the first part and a combination of invoice finance and tighter credit terms for the second. A single $300,000 bank loan or selling 20% of the company might work, but neither matches the need as well.

Questions worth asking for any option:

1. What is the total cost, including fees, not just the headline rate?
2. What security or guarantees are required, and what is personally at risk?
3. How much control or flexibility do I give up?
4. What happens if trading is worse than forecast?
5. Does the business structure suit this type of funding? Equity investment, for example, generally requires a company.

Good funding fits the purpose, the timeframe and the source of repayment. If it does not fit all three, keep looking.

How we can help

We help business owners work out how much funding they actually need, prepare forecasts and financial information lenders and investors expect, and consider whether the structure suits the funding being sought. If you are weighing up options, contact us or read more about our investment and financial advisory work for business owners.

This article is general information only and does not take into account your circumstances. It is not financial product advice. Speak to a qualified, licensed adviser before acting on it.