Rural Business and finance: the types of borrowing and what they are used for

Almost every business, large or small, will require additional funding at some point in it’s lifecycle. There are a variety of funding sources available in a market which although at first glance can look relatively simple, until you look beneath the surface at the actual products, their applications and the implication and cost of using them.

What do businesses need finance for?

Businesses need to raise external finance for many reasons. For many rural businesses these needs include : -

• Restructuring the business’ current debt
• Purchasing a farm or additional land
• Purchasing property
• Purchase new vehicles and equipment (such as tractors and drills)
• Buy new stock
• Development of infrastructure (such as new buildings or milking parlour)
• Diversification
• To buyout family members’ or business partners’ interests in the business or land.

Which type of finance is most appropriate?

With a variety of finance types available, and many seemingly able to finance the same thing, it is important to match the most suitable one to the business in question to ensure it provides not only the funds required, but also at an interest rate and on terms which work best for the business.

The matching process of business and funding source is crucial and not as easy as often initially thought.

Overdrafts, unsecured loans, secured loans, interest only debt, mortgages, hire purchase, leasing, sale & HP back, and sale & lease back are some of the most common types of finance businesses have potential access to. Each has it’s place in helping businesses fund their activities. However, it is key to consider the impact each will have on the business – for example, does it offer the best value? Best value is not just simply the most competitive interest rate on the day the money is drawn down, it encompasses many more elements too.

When considering best value, the loan term and any break clauses need to be carefully assessed. The following are some of the factors which you should consider : -

• If the term is too short, repayments may not be sustainable.
• The initial interest rate may be highly competitive, but if it later reverts to a higher rate, or the future rate is unknown at the time of drawdown, what are the implications?
• Interest only debt may offer lower monthly payments, but at the end of the term all of the original loan value will still be outstanding – how will that be paid back?
• Overdrafts are quick to arrange and easy to draw down but short term in nature – a business does not need to default; overdrafts are repayable on demand.
• What are the arrangement fees? If the funding is subject to breaks, will further arrangement fees be incurred?
• Tax efficiency also needs to be a key consideration in the choice of funding – an unexpected tax bill could wipe out any savings from low interest rates or fees.

When looking for finance, it is essential that businesses discuss their plans their advisers, for example their accountant who can help them determine the best funding source, or combination of sources, clearly laying out the pro’s and con’s of the available choices, and, hopefully helping businesses avoid unforeseen costs and issues.

Our recent webinar - where we were joined by Albert Goodman Accountants Farms & Estates Director Tom Stone and Matthew Smart of Rural Asset Finance Ltd - set out some of the advantages and disadvantages of the more common funding types in more detail. You can watch it again here.