After company formation most companies need extra money to fund their business. Most company’s revenue will not be sufficient enough for investment purposes or major capital expenditure, some may even need money for day to day running of the newly set up company. This procedure of obtaining extra money is known as financing.

 The most common way that companies obtain finance is through debt. The type of debt that company will need to require will depend on what they are planning on using the money for.

 Types of debt

Short term Debt

The requirement of short term debt will most likely be when the company needs to finance the day to day running of the company. This debt will most likely be in the form of an overdraft. An overdraft is an agreement between the company and the bank where the company is permitted to borrow up to a maximum amount on that company’s bank account. As long as the company does not reach its maximum limit then they can fluctuate in and out of their overdraft and at some points may not even be in their overdraft.  The problem with obtaining an overdraft is that it is on-demand. This means that the amount that the company borrowed is immediately repayable on the bank’s demand. This puts the company in a very vulnerable position.

 Another method of short term debt is through trade credit. This is when the suppliers of the company allow a gap between when the goods are supplied and when they receive payment. When setting up a company and choosing suppliers it might be important to go over arrangements for a good trade credit in order to assist the financing of your company. The benefit of having trade credit is that, unlike a bank, the suppliers will not take security over your assets but will instead assume that you will pay as you would want to keep a good credit record.

 Term Loan Funding

When a company needs to finance their capital expenditure it requires a larger amount of money than for day to day running. For these higher costs a company could obtain a term loan. This loan is repaid on specific dates. This could be on one particular date where the loan is repaid in full or it could be a number of dates where the loan is paid off in installments. It is possible to obtain more than one term loan from different lenders in order to avoid one high value loan.  

 For the largest types of money borrowed you are most likely going to obtain a loan. The terms of the loan agreement will depend on the type of loan. A committed facility is likely to be more complex than an on-demand facility as it will have to deal with certain conditions before the deal is made. The loan agreement will set out, the purpose of the loan, the sum which the lender is making available and the terms of repayment. The lender will also put into the agreement the commercial return that he expects to receive. This may be from interest on the amount lent and up-front fee or periodic payments to the lender. There are also events of default that allow the lender to trigger the repayment of the loan.  In any case, arrangement fees are likely to apply.

 Security

If you are able to obtain finance, then the lender will most likely have some sort of security protection against this finance. There are two types of security that are the most common. These are mortgage and charge.

 Mortgage and charge are methods of security that allow the lender to take interest on the some or all of the company’s assets. The borrower still owns these assets but if the money received is not returned by the date set then it is possible for the lender to seize these assets. It is possible to secure different loans from different lenders on the same asset, however this is a risky strategy as if repayments are due then you will have to take priorities over the lenders.

 There is a legal distinction between a mortgage and a charge. A charge does not actually transfer the title of the asset to the lender. However a mortgage takes that one step further and actually transfers the title of an asset over to the lender. This is normally under the condition that the asset will be returned the borrower once the money is paid back.

 A legal mortgage is the most popular as it offers the best security for the lender. This is because the transfer of the title of the assets stops the borrower from using the asset until the debt has been paid. It is not possible to create a legal mortgage over future assets as the borrower must hold legal rights over the asset in order for the transaction to proceed.

 Fixed Charge

In a fixed charge the charge is fixed to the asset so that the borrower is not allowed to deal with the asset while he still has charges against it. This type of security is only really appropriate for permanent assets such as property.  

 When borrowing money it is important to remember that you have to pay it back. You should not try to borrow too much and you should not try to borrow if you do think you will be able to pay back the money. Once you receive a loan you are very much in the lenders control. The lender will able to seize your assets that you have held for collateral and stop you from trading efficiently. It is also possible for a lender to hold collateral against your personal assets. This could be the case if you do not have sufficient business assets to cover the loan.

 For more information regarding lending you will need to speak to your banker or broker.