Many small businesses secure funding using the value of their own homes, but falling property prices means it might make sense to secure alternative funding sources.
Each week auction clearance rates remain subdued and this slowdown in the property market is likely to affect businesses’ cash flow if a loan is secured by a property’s value, according to Rob Lamers, head of debtor financing at Oxford Funding.
‘How big a problem this becomes depends on how much property prices decrease by,’ he says. ‘But when prices drop, financiers adjust their credit lines. Back in the 1990s, property values fell by a third and there were major reductions in financing’.
A property previously valued at $1 million would typically attract 80 per cent funding credit, which means the business could borrow $800,000. A revaluation of that property to $900,000 would mean a business could only borrow $720,000 – a reduction of $80,000.
Lamers says for SMEs, property is the most common form of security provided for financing but this may not be the most appropriate long-term solution, as credit doesn’t increase as the business grows. He says a range of financing options is needed.
One option is debtor financing, which his company provides, and involves having credit secured against a business’ sales invoices. These invoices are assets of the business and increase as sales increase.
‘By leveraging your debtors’ ledger for funds, you can reinvest in business growth without being restricted by the property market,’ Lamers says. ‘If you have debts of $500,000 you can get access to $400,000. All you need to provide is an invoice’.
There are two main types of debtor financing: invoice discounting and factoring. Factoring involves a business supplying goods to a customer and then sending a copy of the invoice to a financier to whom the customer pays directly.
As the business raises an invoice, up to 90 per cent of the value is generally released within 24 hours. The remaining 10 per cent is paid to the business, less a service free, once payment is received from its customers.
The other type is invoice discounting where much the same process is applied but customers are unaware of the funding arrangement and generally pay their invoices into a trust.
How much financing you can get through debtor financing depends on the value of your debt – your invoices. Carl Chatterton is the founder and managing director of L&N Group, which imports building materials to supply to hardware stores.
‘We’ve been going nearly two years and while we initially used our own funds, we were growing so fast we had trouble funding our expansion,’ he says. ‘We chose to use debtor financing to fund our growth and have been really happy with it’.
Chatterton says he can access up to 90 per cent of the value of his invoices.
‘We get charged an administration fee and pay interest on the invoices which fluctuates depending on how much we have borrowed,’ he says. ‘But we find it a really flexible way to secure funding because the amount you withdraw is up to you’.
He says one of the reasons he chose this method was because of the immediate access to funds. Many of his customers do not follow the 30-day payment terms and the time lag in receiving payments can hurt.
‘Also we import our stock and have to pay our suppliers upfront so we need money for that,’ he says.
Chatterton uses the services of Oxford Funding and says it offers different packages, including one where it chases the invoices for payment on his behalf. Chatterton says if you are a new company, financiers may prefer you take out this type of package.
‘There have been stories where companies are sending through dodgy invoices so having a financier chase the invoices and check whether goods and services have been delivered protects them as well,’ he says.
While he couldn’t think of any disadvantages to this type of financing, Chatterton says sometimes his customers raise concerns about needing to pay their invoice to another company.
‘I just explain what debtor financing is and they’re usually fine with it,’ he says. ‘In fact, in a few cases some of my customers have gone out and accessed this type of funding themselves’.