This post is also available in: 简体中文 (Chinese (Simplified))
The Guide of Private Debt Financing For Singapore Companies
Debt funding is one of the choices for first-time business owners who are hunting for small loans or capital to start up their business. Unlike equity financing in which investors acquire equity stakes in the ongoing company, debt financing assists business owners in keeping full control over their company and the profits it earns, if any. In debt financing, you borrow money and accept the obligation to repay in a set period at a specified interest rate. You must repay the cash whether or not your venture is successful. In comparison with equity financing, debt financing is much less costly if your company happens to succeed, but far higher priced if it more likely fails.
The principal source of debt funding for most start-up business owners is a cohesive group of their relatives and friends. However, for a high-growth or capital intensive business, money loaned from personal sources doesn’t always do the trick. Banks and finance companies can fill this gap. In recent years, Singapore banks have seen intense interest in their loan offerings for start-ups. Based on a news report, OCBC Bank revealed that money it has lent for start-ups grew by 10 percent in Q3 2011 as contrasted to Q2 2011. Most finance loan companies and banks in Singapore offer services and products that have been crafted to fulfill the needs of small businesses. These include factoring loans, working money loans and purchase loans.
This guide is an overview of the different private debt options for start-ups in Singapore.
Sources of Private-Debt Finance: Commercial loans
Types of Loans
Most finance companies and banks in Singapore provide small business loans to start-ups. Small business funding is available via overdrafts, revolving lines of credit, factoring loans, etc. The most popular kinds of small business loans offered in Singapore by banks and financial institutions include:
- Working Capital Loans: A short-term working capital loan is normally used to fund a company’s daily business operations. Working capital loans typically support businesses as they try to avoid running out of money until they start earning income. Working capital loans can either be unsecured (no collateral required). or secured (loans require collateral). Unsecured loans require higher interest rates in contrast to secured loans. Unsecured loans are usually approved only for low-risk borrowers. Start-ups involve gigantic risks and are thus expected to get working capital loans that are heavily secured. Working capital loans are designed to finance only short-term needs and are not appropriate for long-term purposes. Working capital loans can be structured as:
- Factoring loans: Factoring loans lend money secured by trade debts. Put simply, it is accounts receivable financing. In other words, you sell your accounts receivable to a factor, usually a bank. The bank lends you an advance collateralized by you’re A/R and your customers pay their bills directly to the bank. No other collateral is needed. Normally, banks lend up-to 90 percent of your A/R or billed invoices. However, be aware that the bank charges an annual interest rate of 5 to 8 percent or a fee between 1 and 15 percent of gross invoice value. The main benefit of factoring is instantaneous access to cash right after you create an invoice. Furthermore, you don’t have to deal with possibly deadbeat customers to get your money. The disadvantages are that your customers may dislike having to deal directly with the banks, and you end up with less than the full value of the invoice.
- Short-term loans: Short-term loans have a maturity period of one year or less. Some banks make you put up collateral to secure the loan. Short-term loans are regularly used to purchase inventory, to smooth out cash-flow, for payroll, to pay bills, etc. Start-ups can apply for short-term loans but must hand over estimated financial statements and exhibit the capability of paying back what they borrow.
- Overdraft: Overdraft is an immediate grant of credit from a bank. By agreeing to an overdraft account, businesses can write overdrawn checks from their current account up to a limit permitted by the bank. Interest is due only on the overdrawn amount and is normally set at 1 to 2 percent greater than the bank’s prime rate. The amount of permitted credit is set by the bank. The benefit of the overdraft account is that it immediately provides short-term cash for activities such as inventory purchases or bill payment, while avoiding bounced checks. Overdrafts can either be unsecured (no collateral) or secured (with collateral).
- Hire Purchase Loans: Hire-purchase is a method of buying merchandise in installments over a fixed period. Hire purchase loans allows bank to finance the purchase of machinery, equipment, or commercial vehicles for company operations. Hire purchase loans are normally used to buy assets that cannot easily be converted to cash. With hire purchase loans, the bank keeps legal title to the financed property until the final installment is all paid-up. In plain language, the hirer buys the assets by putting down a deposit and borrows money to pay monthly installments to the seller over a fixed period. The interest rate of these loans is usually quoted as a flat-rate (a fixed rate for the total amount funded over the complete term). The financing period normally varies from 4 to 8 years, depending on whether the bought asset is used or new. Typically, the loan is for 80 to 90 percent of the market value or purchase price, whichever is less.
Receiving a Start-up Loan: Guidance and Tips
Receiving a business loan from Singapore banks depends on many factors, including:
- A sensible business plan: A financially sensible business plan that elucidates positive economic outcomes is required in order to get your ticket punched.
- Sales Revenue: Higher turnover means better chances of receiving a bigger loan.
- Projected net profit: If you expect reasonable net profits, banks will be more likely to grant you short-term loans for working capital.
- Paid-up capital: Increasing your paid-up capital improves the odds of getting a bank loan, because it shows that the directors and shareholders are committed, as they should be.
- Inventory: It’s better to have fewer finished goods relative to raw materials and work in process, because it tells banks that you don’t have a lot of locked-up capital sitting around gathering dust.
- Start-up owner’s credibility and character: If you can simulate integrity in your business dealings, have a good credit history and reputation free from scandal, you’ll go far towards winning bank financing
- Collateral: Banks like to see collateral and plenty of it if they are going to lend you money.
- Economic conditions: It’s better for your startup to be in an industry with positive factors such as favorable barriers to entry, good economic outlook, lack of currency risk and insensitivity to the external environment, because these factors weigh heavily on the minds of bankers as they decide your fate
- Debt-equity ratio: Just about all banks look at the debt-to-equity ratio of start-up ventures. In plain terms, this means that the loan request should be convincing when compared to the money that you have already sunk into the business. The loan you apply for should be some percentage of the capital already committed.
- Loan application: Bankers venerate the loan application when you apply for a business loan. The loan application must come clean, disclosing items such as: the kind of loan, the loan amount, why you want the money, can you repay the loan, and just how far would you go to get the loan for your start-up. You must also reveal details such as: What will your business activities be, who exactly is on the management team, information about your market, financial forecasts, and the how you plan to come up with collateral.
Sources of Private-Debt Finance: Friendship Loans
The primary source of private debt financing for start-up visionaries is money siphoned from family and friends.
The benefits of friendship loans are:
- Your sources usually won’t ask for collateral unless they don’t trust you;
- You can make up any loan terms you wish;
- The repayment schedule, loan period, and other details can be hammered out amongst the parties
- The loan arrangement is often based on trust (whether misplaced or not) and unenforceable verbal assurances, although your friends may want something in writing that sets downs all conditions and terms to keep things business-like and prevent family feuds.
- Make sure you keep lenders informed about how the business is doing. You can provide a business plan at the start of the loan and forward progress updates to keep the peace at family gatherings.
- You’d be surprised by how many Singapore start-ups were first funded by “loans” from friends and family that may or may not have ever been paid back.
If you swear to repay the business capital loans on time, most finance companies and banks will find some way to offer a business loan with decent terms. Give lenders a few weeks to mull your application. Frankly, banks don’t trust startups because the vast majority fail, usually due to anemic cash-flow and puny capital. You’d better try to find a willing bank and say whatever is necessary on the loan application to reduce the likelihood that the bankers will toss out your request.