The world of business financing is a complex one, which can cause owners to overlook suitable options for their needs. My Business breaks down the main short-term business financing option, including the often misunderstood caveat loan.
Structured for only a one- to six-month term, a short-term business finance or a caveat loan settles rather quickly, in general within 24 hours after the application’s first lodgment. Because of this setup, there is no time for the formalistic bank-style due diligence, as well as valuations. Most often, a bad credit history is also overlooked and is therefore deemed irrelevant.
Simply, a short-term business or caveat financing is securing a loan against a property or a piece of real estate—your family home, a commercial property, or a piece of land. The lendee then attends to their debt repayment obligations at a time already predetermined within the next few months. Thus, an asset lending process, and an exit strategy.
Debt repayment can be done through several options: asset sales, your business’ cash flow, a refinance, or a commission due. Any verifiable avenue is a welcome and suitable exit strategy.
Many businesses, especially in Australia, would find it hard to thrive, if not exist at all, without short-term business financing or the caveat loan option. Below are some of the most common examples why short-term business financing and caveat loan are deemed important in the business and financial industry, particularly in Australia:
- Cash flow challenges
- Council approvals or head works
- Payment of outstanding invoices
- The purchase of a business
- The purchase of real estate not for personal purposes
- The purchase of a stock/share
- Taxation debts
- Start-up cost financing
Short-term business financing is broadly categorised into two:
- Unsecured loans
- Secured loans
This type of business finance loans is not secured against anything of value. Instead, the fund is being lent against the lendee’s capacity and ability to attend to their debt repayment obligations as well as their previous behaviour on funds repayment.
Naturally, only a small number of lenders in the market are willing to take such high risks granting unsecured business loans, compared to granting loans for more personal purposes. The majority of unsecured loans are only that of credit cards from financial institutions such as banks, and from credit unions.
On the other hand, secured loans are the majority of business funding enjoyed by companies and business individuals across the country. Of course, as the term suggests, this type of loan is secured against something of relevant, considerable value. It can either be secured by the company or against tangible assets; for example, your family home, other real estate properties, cars, even boats and/or yachts.
The logic behind secured loans is to offset the very real risks that are often associated with business loans for the financing establishment or institution. If the debtor defaults and thus becomes unable to attend to their debt repayment obligations, the financing/lending institution can then seize the asset(s) tagged as security or collateral, then put up said asset(s) for sale to try and recover the loan amount. Of course, most established financial institutions only do secured loans.
The following are the most common types of secured loans and/or funding, particularly in Australia:
- Bank guarantees
- Caveat loans
- Debtor financing
- Leases and hire purchases
- Line of credit
- Mezzanine finance
- Mortgage financing
- Personal property security secured loans
Available from and offered solely by banks, credit unions, and other similar financial institutions, bank guarantees work with the client depositing the guarantee amount to the bank as cash in a term deposit or providing real estate as collateral/security. The lending financial institution then issues a guarantee to pay the amount in the event of a default. This type of secured loans is usually provided for leases on retail and commercial businesses.
This type of funding is secured by a caveat-only real estate. The debtor lodges a document on the government records of ownership—the title—of the real estate. This caveat document effectively puts a stop or will stop all other dealings on said secured property. This serves as a warning and prevents the sale of the collateral property, informing all other lenders that the said property has already been used for security.
Simply, a caveat doesn’t allow lending financial institutions to sell the collateral property but lets them have an equitable interest in it. Note that most lenders advertise that they offer caveat financing, but most of them are only really just taking second mortgages and calling them caveat financing.
Invoice financing and/or factoring finance, this type of loan is secured against outstanding incoming invoices. The lending institution will be provided by the debtor with a set of invoices for work or venture that has already been completed but is still awaiting payments. The lending institution then proceeds by advancing funding to the debtor and transferring ownership of said invoices to the lenders and then collecting relevant payments.
Leases and hire purchases
Used by companies and businesses to acquire tangible, operations-relevant assets such as machinery, equipment and vehicles, this type of secured loan is usually favoured because of its tax benefits.
Line of credit
Similar to a mortgage loan but with added treats and features, this type of secured financing allows you to pay down the loan with as much as you can and want to, at usually no added cost. This allows for reduction of the interest cost, you, as debtor, have to pay, which also enables lendees to redraw said funds when necessary.
This type is secured only against the company or business itself. Thus, the firm or business applying for the loan tags the company as collateral against the debt. In the event that the company fails to complete debt repayment, the lending institution will then be given the right to convert the ownership of the said firm/company to themselves, choosing to either keep it or put it up for sale.
This loan is realised when a registered or unregistered mortgage is put up as security. A land document, the mortgage is lodged on the title and protects the lending institution’s interest in the said property. In the event of failure to repay the debt or a default, the lending institution is given the right to put up the property tagged as security for sale. Depending on the title and which Australian state or territory the property is located, a mortgage generally takes from seven days to around six months to be registered on title.
One of the most well-known benefits of a mortgage in comparison with other secured financing options is that it allows for multiple lenders to provide funding against the property. Called second mortgages, the second financing institution is also ranked second in priority, next to the lending institution registered on title.
The mortgage financing option is the most offered and most availed secured loan financing in the business finance industry, particularly in the Australian setting.
Usually attached to a trading bank, this type of loan is offered by banks, credit unions, and other similar financing institutions. When necessary, they allow the business to place the account in the negative for the business to continue its operations.
They also range in size or scope, depending on the security tagged by the debtor. Note that even in some cases, they can even be considered unsecured financing in very small amounts.
The advantage of overdrafts is that they allow for businesses to repay the debt automatically as the loan rolls into the firm’s trading bank account and as their business improves and gains financial stability.
Personal property security secured loans
This secured financing alternative is under the Personal Property Security Register and is also secured against it. It allows lending institutions to secure interest over tangible assets such as boats/yachts, cars, helicopters, and planes, even tractors, trucks, and anything of relevant and considerable value. This type of financing can be done and completed really quickly and conveniently, too.
Note that to avail this secured financing option, the debtor should not have any other debt repayment obligations placed on the asset, and should also be the true, legitimate, and beneficial owner of the asset in question.
In deciding which financing option suits you and your business needs, you can always seek informed professional advice from your accountant, finance lawyer, or even your bank.