How can I minimise my risk with the banks?
This article first appeared on November 11, 2010.
I’m seeking finance for my business but, after speaking to a few banks, it looks like I’ll have to put my house on the line as security.
I’m quite nervous about doing this. Is there any way I can minimise my risk with the banks to put me in a better position?
Your situation is very much the norm in this post-GFC era for the start-up and micro- to medium-sized business sector. This is evident not only in Australia but worldwide, and reflects the ongoing tightness in credit markets and what seems to be a preference by banks for lending in the residential space.
You are quite right to question whether you should mortgage your home - this is a risk management question that must be carefully considered. Some issues and options to consider include the following:
- Quantum of borrowings - How does the amount of borrowings compare to the value of your home and the available equity (after any existing mortgages you already have)? A $50,000 loan on a home worth $700,000 with little or no other debt represents a much lower risk than borrowing up to 80% of the value of the home.
- Business Risk - Assess the level of risk in the business. Is the business a start-up or has it been operating profitably for a period of time? Does it have strong asset backing and revenue projections? Look at the business objectively - is there a high probability that the business will be able to repay the debt?
- Purpose of the borrowing - What is the purpose? If it is related to business expansion or to the acquisition of equipment that is needed, there is probably less risk than if it is for working capital purposes because the business is making losses or to pay the Tax Office.
- Seek Advice - Run the scenario past your accountant who can be more objective than you about your business and the risk issues. Also discuss your needs with a finance broker who may identify other options given your unique circumstances or perhaps lenders that are more willing to lend without requiring your property as security.
- Equipment Finance - If the finance is required for the purchase of equipment, consider the various forms of equipment finance available - chattel mortgage, lease or hire purchase. These are secured against the asset and usually with director guarantees, but generally do not require property security.
If you have equity in existing equipment, investigate whether you can obtain sale and leaseback finance or alternatively sell down some of the equipment, thereby releasing cashflow and finance the purchase of replacement equipment. You need to consider transaction costs with this option.
- Debtor Finance – Security requirements vary, but traditionally focus on the value of the debtor’s ledger, supported by charge or mortgage over the business, along with the personal guarantees of directors. Debt factoring is essentially where you collect all or a proportion of the invoices you raise and the finance company is paid when the debtors settle their account.
These forms of finance are more expensive that many other forms of finance but can be appropriate where property or other security is not available and can fund the growth of a business.
- Goodwill Lending - This is available in some sectors such as some franchises and certain professional sectors such as pharmacy, medical, etc.
- Merger or Introduction of Equity - It may be an appropriate time to consider merging with another business which results in the "sum of the total being greater than the individual businesses" and where finance or cashflow may become available. Similarly, consideration could be given to introducing a partner or even selling off part of the business.
In summary, it is prudent for you to question the risks of using your home as security for debt in your business. It may very well be appropriate to do so, once risk and alternatives are carefully and fully assessed.
Written in conjunction with Jason McGowan, finance specialist at CDB.