Growing a business usually requires money.
You might need a new ute, excavator, tractor or piece of equipment. You may need extra cash to take on a bigger contract, pay wages while waiting for customers to pay, manage a tax debt or deal with an unexpected problem. For many small business owners, the first funding option offered is to borrow against the family home.
After more than 40 years working with small businesses, I believe this is one of the biggest hidden risks owners can take without fully considering the alternatives. There are circumstances where using home equity may be necessary or appropriate. But it should not automatically be the first or only option considered.
Why banks often ask for the family home
Residential property can provide a lender with strong security. From the lender’s point of view, that may make the application simpler. From your family’s point of view, however, it connects a business debt to your most important personal asset.
A business can experience trouble for many reasons:
- a major customer pays late or does not pay
- an important contract is lost
- equipment breaks down
- costs increase unexpectedly
- the owner becomes sick or injured
- the business has a difficult year
Even a good operator can face circumstances outside their control. When the family home is used as security, a business problem can potentially become a much bigger personal problem.
The quickest option is not always the best option
Many business owners arrange finance when the situation has already become urgent.
Perhaps the excavator has broken down halfway through a job. A large customer is 60 days late paying an invoice. A tax bill has arrived at the same time as wages and supplier payments.When the pressure is on, it is easy to accept the first available option.
That is why it is better to investigate finance before the money is desperately needed. You have more time to compare the costs, security requirements and repayment terms.It is also worth speaking with a commercial finance broker rather than assuming that your usual bank or home-loan broker has considered every available business funding option.
Alternatives that may be available
The right option will depend on your business, what the money is for, how long you have been trading and the lender’s requirements.
There are no guarantees, but some businesses may be able to obtain finance without putting a mortgage over the family home.
Equipment finance
If you are buying a ute, truck, excavator, tractor, trailer or other business equipment, the lender may be able to use the asset being purchased as security. It is not limited to vehicles.
Depending on the lender, equipment finance may be available for machinery, workshop equipment, commercial kitchen equipment, medical equipment, technology and many other income-producing assets. For example, a Newcastle builder buying a work ute or a Hunter Valley farmer replacing a tractor may be able to investigate finance secured by the vehicle or machine rather than the family home.
Short-term cashflow finance
Some lenders offer business finance based on the strength and cashflow of the business rather than residential property.
They may consider matters such as:
- how long the business has been operating
- its turnover
- recent bank account activity
- existing debts
- repayment capacity
- the credit history of the business and its owners
This type of finance can be more expensive than property-secured borrowing, and a personal guarantee may still be required. It should be assessed carefully rather than treated as easy or risk-free money.
Business assets or balance-sheet lending
A lender may sometimes consider business assets, equipment, stock or the overall financial strength of the business as part of the security arrangement.This can be useful for established businesses that have built up assets or a strong trading history.
However, you need to understand exactly which assets the lender will have rights over and what will happen if the repayments cannot be made.
Invoice finance
A profitable business can still run short of cash when customers take a long time to pay.
For example, a Lake Macquarie contractor may finish a large commercial job but need to pay wages and suppliers several weeks before the customer pays the invoice. Invoice finance may allow the business to access part of the money tied up in approved unpaid invoices.
Fees and conditions vary, and not every invoice or business will qualify. But it may be worth investigating when slow-paying customers are creating a genuine timing problem.
Private investment
Some businesses may also be able to raise money from an investor rather than borrowing it.
This means giving the investor a share of the business, so it is very different from taking out a loan. It may also mean giving up some control. Legal, accounting and commercial advice is essential before entering this type of arrangement.
What about tax debt?
Tax debt is a common reason business owners consider borrowing against their homes.
Before replacing a tax debt with a new loan, it is important to compare the full costs and risks. Depending on the circumstances, possible options may include:
- discussing a payment arrangement with the ATO
- refinancing the debt
- using short-term business finance
- improving debtor collection
- selling unused business assets
- restructuring other business debts
The right approach will depend on the business’s cashflow and whether it can meet both its current obligations and the new repayments.
A finance broker should work alongside your accountant when tax debt is involved.
Get finance-ready before you need the money
The best time to arrange business finance is before the situation becomes urgent.
Start gathering:
- recent financial statements
- lodged tax returns and BAS
- business bank statements
- details of current loans
- a list of business assets
- unpaid customer invoice reports
- quotes for equipment being purchased
- a simple explanation of how much you need and what it will be used for
Different lenders will request different information.
Having your paperwork ready gives a broker more options and makes it easier to identify potential problems before an application is submitted.
Already using the home as security?
It may still be worth reviewing your current arrangements.
As a business becomes more established, builds assets or improves its financial position, other options may become available.That does not mean the home can always be removed from the arrangement. Refinancing may also involve fees, valuations and new lending conditions.
However, you will not know whether a better structure is possible unless you ask.
Speak with a commercial finance specialist first
Using home equity for business finance is not automatically wrong.
In some circumstances, it may be the most practical option. The important thing is to understand the risks and compare the alternatives before making the decision.Whether you need finance for equipment, working capital, unpaid invoices, commercial premises, tax debt or a growth opportunity, there may be other ways to structure it.
A phone call or coffee with me costs nothing.Imagine what it could save you!.
Speak with The Finance Shed about business finance options in Newcastle, Lake Macquarie, Maitland, Port Stephens, the Hunter Valley and across regional NSW.
This article contains general information only. It does not take into account your personal circumstances, business position or financial goals. Finance availability, costs, security requirements and lender criteria vary. Consider speaking with a finance broker, accountant, lawyer or other qualified adviser before making a major financial decision.