Debt financing is often overlooked by start-ups and scale-ups. But it’s a vital source of funding that’s more accessible than many innovation businesses realise. Rising inflation and venture capital that’s increasingly elusive mean it’s more important than ever to weigh up your options when it comes to funding. So we’re taking a deep dive into debt financing in all its forms and examining the pluses and minuses for businesses accessing it in the current climate.
What is debt financing?
Debt financing, in essence, is a loan. It’s capital you borrow from a lender and repay with interest. You and your financier will also agree on terms and conditions for the credit. It comes in all different shapes and sizes. A host of factors, including your company’s profitability, assets and ownership play into deciding which financing is the right choice for your circumstances.
Debt financing explained
Just as there are different ways to skin a cat, there are different ways for lenders to package finance products for borrowers.
Secured vs unsecured debt
Debt financing falls into two distinct categories: secured and unsecured. Whenever borrowers are required to provide collateral to secure their loans, they have a secured debt. If the borrower defaults on a secured debt, the assets they’ve provided as collateral go to the lender as repayment. Unsecured debt, as the name suggests, is a loan that doesn’t require any collateral as security. It carries a personal liability for borrowers instead. So if a borrower defaults, the lender can pursue them personally for repayment.
Swings and roundabouts
Whether debts are unsecured or secured usually comes down to a balance of risks and benefits. Lenders will typically require security on larger loans. In return, especially if the finance is over a longer period, they may offer a more competitive interest rate. An everyday example of a secured loan is a commercial property loan on business premises. By contrast, with unsecured borrowing, lenders tend to put a lower ceiling on how much they lend. And interest rates on unsecured loans tend to be higher. An everyday example is an unsecured business bank loan.
Types of debt financing
When we think about debt financing, bank loans usually spring to mind first. But they’re by no means the only show in town. The rise of alternative finance and fintech platforms over the past eight years has given businesses, big and small, more options when it comes to debt financing. And with economic conditions set to get tougher, if you haven’t reviewed what’s on offer in terms of business financing, there’s never been a better time to do so.
Keeping things traditional
Established products such as business loans, overdrafts and credit cards from traditional banks can be challenging to access for innovation businesses, especially in the early stages. But if your business is growing and has been around for a few years, it could be time to take a close look at traditional finance products. And even if you have a newborn start-up, talking to your bank manager is still worth a shot. The good thing about traditional finance is that it’s tried and tested. Even if you aren’t successful with a finance application today, you’ve put your business on your bank’s radar, and you can also reapply once you meet their lending criteria.
Bank loans for your business
The big four high street banks, such as CommBank and ANZ offer businesses a range of secured and unsecured loans. But R&D can be expensive, so even if you pass the eligibility test, an unsecured bank loan may not be enough to reach your innovation goals. And secured borrowing from the bank often involves offering up your family home or business premises as collateral, which simply may not be an option.
Overdrafts differ from bank loans in a few crucial ways. They are lines of credit that provide flexible, short-term cash flow that you access from your business transaction account. There’s no hard and fast time limit or repayment schedule for an overdraft, although you and your bank can agree on an expiry date. You pay a fee to set up the overdraft and then repay interest on the balance. Overdrafts can be unsecured or secured. And it probably comes as no surprise that having a large overdraft from a high street bank, say $250,000-$1,000,000 will involve you stumping up collateral that meets your bank’s lending criteria.
Business credit cards
Business credit cards provide unsecured financing and are available from banks or directly from credit card providers, such as AMEX. There are different types, such as low rate, rewards and frequent flyer credit cards. It’s worth taking the time to consider the card’s terms and conditions then compare these to how you plan to use the financing before choosing the best match for your business.
Exploring the alternatives
If you’re drawing a blank with traditional credit or want financing that’s more flexible or competitive, what are your options? Alternative financing became a buzzword in the previous decade. But in 2022, the term is increasingly becoming a misnomer. Alternative financing is becoming more mainstream with every passing day.
Peer-to-peer lending platforms
If you’re wondering where you can get a business loan without going to the bank, put peer-to-peer lending on your review list. Peer-to-peer is crowdsourced finance that’s typically more accessible to innovation-focused and early-stage businesses. Lenders, for example, Australian-owned Prospa, offer crowd-based debt financing of up to $150,000 on an unsecured basis and secured loans of up to $500,000. But conditions apply. Being able to demonstrate that your company has been trading successfully for multiple years, and that it can meet additional eligibility criteria relating to turnover and loan terms is a must. In return, business borrowers can enjoy lower interest rates than they would with a bank.
Buy Now Pay Later
Buy Now Pay Later (BNPL) does exactly what it says it will. Initially the domain of consumer markets before crossing over to the business sector, companies such as Australian BNPL operator Zip offer unsecured business loans of up to $500,000. In our blog, Innovation funding trends founders need to know about, we flagged how spiralling inflation and interest rates have ushered in painful losses for BNPL players worldwide. But with regulation set to arrive for the sector for the first time, and sooner rather than later, BNPL is likely to remain another source of alternative finance for some businesses.
Revenue-based financing is a lump sum payment from a lender in exchange for a percentage of the company’s revenue. Melbourne-based Tractor Ventures is a homegrown provider of this financing. The lender offers finance between $50,000 and $1 million to businesses in Australia and New Zealand that are generating regular monthly revenues of $15,000 and upwards. In return for the capital, borrowers pay 5%-15% of their monthly revenue to Tractor Ventures. If you’re not generating enough regular revenue, then revenue-based financing will be off the table for now.
R&D financing is a loan that enables businesses with eligible R&D to gain early access to their expected R&D Tax Incentive (R&DTI) refund. Both non-revenue and revenue-generating companies can be eligible, providing they qualify for the R&DTI refund. The Radium Advance from Radium Capital is an example of this type of debt financing. But what makes this offering unique is its supreme flexibility and scalability. After you have spent money on R&D, you can access your expected R&DTI refund whenever you want and as many times as you need to throughout the year. And there are no minimum or maximum loan amounts either. As long as your business is eligible for an R&DTI refund, your business can apply for a Radium Advance, whether you have no turnover or an aggregated annual revenue of up to $20 million. It’s perfect for early stage, non-revenue start-ups or those with lumpy income. And it can support later stage ventures and scale-ups too.
Borrowers have a high degree of certainty because Radium Advances have fixed interest rates and affordable establishment fees. Typically, your Radium Advance will be secured against your expected tax refund, which means having R&D financing doesn’t diminish your company’s ability to access other forms of financing.
Upsides and downsides
Like any source of capital, there are pluses and minuses of debt financing for businesses with R&D. Let’s take a look at the main ones and consider how the looming recession is likely to impact debt financing for innovation businesses.
1. Ownership and control
One of the main drawcards of debt financing is you keep ownership of your business and control of how it’s run. When you attract an investor, the opposite is true. You trade some of your business equity, i.e. ownership and a say in how it operates, for capital.
2. Paying less tax
Another benefit of debt finance is that the interest you pay is tax deductible.
The principal sum, i.e. the amount of capital you’re borrowing is a known quantity. And if you choose a fixed interest rate and follow the agreed repayment plan, budgeting and financial planning for your business are easier.
With traditional and alternative financing products on the market, it’s likely your start-up or scale-up will be able to access funding to progress your innovation. Unfortunately, the same cannot be said for equity financing from investors. Venture Capital was always hard to land. But now deals are down across the board, and it’s not clear if we’ve hit the bottom of the market. In our blog, Raise capital in a recession and get investors hooked, we examine the best way to reel in investors amid the current climate. But all of that takes time. And if you don’t have time, then debt financing is a better option.
High inflation can be your friend when you have debt financing because it effectively reduces the value of your loan. So providing your business income rises with inflation, you will have more revenue coming through the door relative to the principal debt you owe.
Essentially, when you take out any loan or credit, you’re betting on the future success of your business. And if that bet doesn’t work out, that’s a problem, because you won’t have the income you need to repay your loan. By contrast, you don’t need to repay equity financing. So if your venture fails, while you won’t be popular with your backers, you won’t lose your shirt.
2. Credit scores and bankruptcy
If you start racking up late or missed repayments, it can adversely impact your personal and business credit ratings. This could make it more difficult for you and your business to borrow capital in the future. If things go south irretrievably for your innovation venture, any capital you have borrowed must be repaid, which could put you at risk of bankruptcy or insolvency.
3. Interest rates are rising
Interest is the cost of borrowing money. With rates rising around the world, and in Australia every month since May 2022, debt financing is becoming increasingly expensive. That being said, while venture capitalists don’t charge interest; if you do secure funding from them now, they require more equity than before. So the cost of funding, however you measure it, is increasing across the board.
Debt financing and business stage
There are a few key factors to consider when choosing debt financing for your business.
Why does your business need funding?
This often-overlooked question is top of our list for a good reason. Borrowing money can have long-term ramifications (good and bad) for you personally and your business. So it’s crucial to be crystal clear on why you’re taking on debt, and what you’ll use the borrowing to achieve.
How much capital do you need?
Size matters when it comes to loans because what you borrow impacts your budgeting and your wider financing strategy. Is it seed money to get you off the ground, or a secured loan to expand and scale up your operations? Answering this question can help point you in the right direction for the debt financing that’s the best choice for your business goals.
What are your business circumstances?
This gets to the heart of eligibility and whether you will meet a financier’s lending criteria. Factors you need to consider are your personal credit score, your company’s credit rating, how long you’ve been in business, your annual revenue, and any existing debt financing you and your business has.
How quickly does your business need to access funding?
Different types of financing have different lead times. Factors that impact the speed at which you can access funding include whether you’re applying for a secured or unsecured loan, or whether you’re dealing with a bank or an alternative financier. The latter tends to have faster turnaround times, but not always.
How much debt can your start-up or scale-up afford?
When you take on debt financing, you need to service that debt by following the lender’s required settlement plan. This will involve you repaying the principal and interest within a set timeframe. Variables that play into what you can afford to borrow include when you need to repay the loan, and where you will find the money to do so. For example, with a Radium Advance, your expected R&DTI refund from the ATO is earmarked to repay your loan. And the finance is structured in a cash-flow-friendly way so there are no repayments or fees due until the refund arrives.
In broad strokes, if your start-up is late stage or more established and is generating revenue, you will have access to more types of debt financing — secured and unsecured.
R&D finance and your business
Whether your business is at an early stage or scaling up, if you have eligible R&D expenditure, Radium Advances are an option. If you’re interested in learning more about R&D financing, we have a team of experts who can help you. We’ve worked with businesses of all sizes, stages and provided loans from $7000 to $10,000,000. Contact us to discuss how we could connect your business with the funding it needs.
 Michael Pascoe. 2022. Tide going out on Buy Now, Pay Later. [ONLINE] Available at: https://thenewdaily.com.au/opinion/2022/11/04/bnpl-tide-going-out/
 Gené Teare. 2022. Global VC Pullback Is Dramatic In Q3 2022. [ONLINE] Available at: https://news.crunchbase.com/venture/global-vc-funding-pullback-q3-2022-monthly-recap/.
*Radium Capital is a specialist R&D financier. The information contained in this article is general. It is presented for information purposes only. It does not amount to advice and should not be considered as such. Radium Capital recommends that any business assessing its eligibility for the R&DTI and preparing an R&DTI claim should seek the advice of an R&D Tax Consultant. When considering the most suitable debt financing products for your business, we recommend you seek the advice of business and financial advisors.