Overdrafts and bank loans

Don't make the wrong choices when seeking finance

Every business has cash flow issues whether you like it or not. You’ll have to borrow money, and may have to do so at your start-up point. But what’s the best way to do it?

The simplest way to get at business capital is to ask the bank. If you have a sensible business plan they’ll almost certainly say yes. There are a lot of arguments in favour of using this sort of financing, chief among which is that you’re not going to give away any equity in your company and you’ll almost certainly be offered some free business advice along the way.

Your bank will want some sort of security, and if you’re starting up this will almost certainly involve your house. If you can resist this at all then by all means do – nobody wants to lose their home and although you might have faith that your business will succeed, there is no absolute guarantee of this. Other elements that will impress your bank will include:

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What's it for?

Whether a loan or an overdraft is more appropriate for you will depend on what you need the money for. One-off capital needs are best met by a loan (although if you have already been running for a while you might wonder why you actually need another lump, unless you’d anticipated this in the beginning).

�Cashflow issues are best met by a short-term overdraft facility.�

Cashflow issues are best met by a short-term overdraft facility. Remember, the bank can call in an overdraft at any time without warning, but mostly they don’t and it’s a flexible way to borrow. Remember also that there can be penalties if you want to repay a bank loan early.

Costs can be considerable. The bank will want an arrangement fee and then interest payments will depend on the market at the time. Banks may also want quarterly reviews, for which they will charge. Plus, penalties for late payment can be extortionate, either in one-off fees, or a higher long-term interest rate. The less reliable you are in honouring your repayment commitments, the higher the interest rate you’ll be charged when you come to borrow again.

The overriding factor that pushes people towards the bank loan / overdraft model, however, is an unwillingness to give up equity in their company. This sounds compelling, doesn’t it? But when asked whether she used an overdraft or bank loan to fund business networking group The Glasshouse, founder Judith Clegg says she preferred to approach a business angel and venture capitalist. “We felt they understood and could support out business in a way that the banks we spoke to were too rigid to do,” she says.

In general, banks have lots to offer for ventures which fit into the mainstream: opening a shop, for example. Franchisees too can glean plenty from the high-street banks. But if you’re into anything beyond the ordinary, from aeronautics to zoology, a business angel might be a better place to start.

What next?