What is a pre-pack insolvency arrangement?
Pre-pack insolvency arrangements (pre-packs) are still relatively unorthodox in Australia but are implemented regularly in the UK. If properly planned, pre-packs are legal and allow a business to be rescued through a quick transfer of the assets of the insolvent company. To learn more, watch our seminar and read our accompanying blog post: Legitimate pre-pack insolvency arrangements versus phoenix activity.
|Type of Finance||Security||Typical Providers||Typical Interest Rates (range)||Loan Purpose|
|Receivables finance||Purchase of receivables is required. The financier may also require a general security agreement||Niche finance providers and banks||12% on drawn funds, with a further 3% on total invoice value plus other fees and charges
|Promotes cash flow and protects business from delayed payment from debtors. Also outsources collections.|
|Equipment finance||At a minimum, security taken out over the relevant equipment||All major banks, as well as various smaller finance providers||Varies depending on risk
|Provides finance for the purchase of new equipment|
|Personal loan||Largely unsecured, dependent on provider, sometimes residential or commercial property or business assets are required||All major banks, as well as various smaller finance providers||(8%-22%)||Provide funds, lent to Director for working capital|
|Credit card||No security required||All major banks||(14%-22%)||Varied|
|Bank overdraft||Dependant on provider, sometimes residential or commercial property or business assets are required||All major banks||(8%-20%)||Gives business a solution to short term liquidity crises|
|Mortgage finance||Residential or commercial property||All major banks||(5%-9%)||Provides funds secured by real property, often residential property|
|P2P Lending||Varies from lender to lender||Think Cats Australia, OnDeck, Marketlend||(8% – 17%)||Connects borrowers with individual lenders through online platform|
|Friends, Fools and Family||Not required||Parents, extended family, friends||N/A||To provide necessary funding to the business|
Receivables finance (also called debtor finance or discounting invoices), is the purchase of a company’s debts that facilitates the company to receive income from their invoices as soon as they are issued, rather than waiting for clients to pay at the end of often long payment cycles. Banks and other lenders who offer receivables finance advance to a company a percentage of the invoice amount after it is issued, alleviating many of the issues that come with poor cash flow. Often receivables financing is attractive to small businesses as there are minor credit requirements on the borrower. A receivables financier will be primarily interested in the quality of the debt that is owed to the business rather than the profitability of the business itself.
Receivables financing can be divided into two separate categories. The first category is not visible to the debtor. In this form, the business receiving the finance obtains money from the financier on the presentation of an invoice and the financier decides whether or not to fund the invoices on an individual basis. The invoice is still remitted to the company however, and the company remains responsible for their own collections and for paying back the money to the financier.
The second category is visible to the debtor and the market. This is the form of financing typically provided by smaller finance providers who specialise in receivables finance. The receivables are normally assigned to the financier in their entirety. The financier then advances a percentage of funds (usually 60%-80% of the invoice value) to the borrower against the invoices as they are issued. When the invoice is paid in full the remainder of the funds are paid to the borrower, minus interest and fees. In this category the invoices are actually remitted to the financier with the monies being paid into an account controlled by the financier. Therefore, the financier also takes charge of collections. This style of financing is attractive to businesses wishing to outsource their collections and focus on their core profit making activities.
Receivables finance can also be used for Newco to immediately obtain a sum of money in order to provide consideration for the purchase of Oldco. This will help a director to limit the amount which they may need to provide security for, or borrow in their personal capacity, but it will reduce the ability of Newco to purchase inventory without further funding. Unlike many other forms of finance that may be available, this will not necessarily require Newco to put up any collateral as security, which can be a major advantage. However, as with any type of finance, it does come at a cost, with companies that provide receivables financing generally charging relatively high fees, as well as charging high interest on the amount that is advanced. There are also penalties involved if Newco’s debtors are slow in repayments.
- Advantages of Receivables Finance: Improves cash flow, credit checks performed on debtors rather than borrower, No restrictions on what funds are used for
- Disadvantages of Receivables Finance: High rate of interest, potentially damage business relationships by having collections conducted by third party
- Current Providers of Receivables Finance: Cashflow Finance, Scottish Pacific.
Equipment finance is finance granted with security taken over a business’s physical assets. As security is provided it generally has a lower interest rate than unsecured borrowing, however it will have a higher rate of interest than borrowings secured by real property. For example, equipment financing could be used to purchase cars for sales representatives, plant or machinery necessary for the production of a business’s product or computers for an office. In a pre-pack scenario, Newco could request the novation of the loan to ensure the conveyance of the equipment from Oldco to Newco.
The structure of equipment finance can vary greatly, with some being lease back arrangements where the bank retains title of the purchased equipment, with others having the business retaining title while the bank retains a security interest. Typically, the lender will also require the directors to provide personal guarantees in order to secure an equipment finance loan.
- Advantages of Equipment Finance: Reduced interest rate as security provided, very useful for purchasing new plant and equipment
- Disadvantages of Equipment Finance: Restriction on what money can be used to purchase, personal guarantee
- Examples of Current Providers of Equipment Finance: All major banks
A personal loan taken out in the name of a director can be a convenient way to raise money for a business quickly. It can be used in times when cash flow is poor in order to boost funds for the company, and is also potentially a source of funding for the purchase of Newco from Oldco. However, because this loan is taken out in a personal capacity it adds a degree of risk.
Personal loans are also offered by lenders of “last resort”. These loans have very high interest rates, with rates sometime being as high as 55% per annum and often with significant additional fees. Even personal loans from major banks have high interest rates with unsecured personal loans from banks and credit unions having rates ranging from 9% to 22%.
Taking out a personal loan for a business should be avoided if possible as it exposes the company director to the kind of personal liability and financial risk that use of the corporate form is designed to minimise.
- Advantages of Personal Loans: Access to funds that are otherwise unavailable and speed
- Disadvantages of Personal Loans: High rate of interest, personal liability
- Examples of Current Providers of personal loans: All major banks, GE Money, Rate Setter, RACQ, Society One, Various credit unions.
A director’s personal credit card or a credit card in the name of the business can be a source of finance for a business.
Credit Cards are an attractive source of finance as:
- The money provided by a credit card is flexible, and there are no limitations by the bank on how the funds can be spent.
- The money is easily accessible, with credit cards being accepted by most suppliers
As credit card interest rates are often around 20% per annum this should be treated as a last option and should not be used for debt that will not be paid off promptly. The interest rate charged is further amplified because credit card interest compounds monthly. This effect is further multiplied if one card is being used to pay off the interest on another.
- Advantages of a Credit Card: No restrictions on what money is used for, money easily accessible.
- Disadvantages of a Credit Card: Very high interest rate, Director typically personally liable.
- Examples of Current Providers of Credit Cards: All banks.
A bank overdraft can be an effective way for a business to access finance. An overdraft, like a credit card, gives a business access to a set amount of funds. Rather than being tied to a repayment schedule, as with a personal loan, the business pays interest on funds that are withdrawn at regular dates (i.e. monthly). This has the advantage of allowing the business to keep their repayments to a minimum during times of stress. As an overdraft is typically continually available, it can be applied for during a time of financial stability, with funds then being available during a short term crisis.
An overdraft is typically attached to a business transaction account. As the facility is offered by a bank, the approval process is more onerous than with niche financiers. It is also common for the bank to require the directors of the company to provide personal guarantees to secure any amounts borrowed. Interest rates for an overdraft are also relatively high, with rates of around 15% being common where no additional assets have been given as security.
- Advantages of a Bank Overdraft: Flexible facility – only borrow the amount needed, always available
- Disadvantages of a Bank Overdraft: High rate of interest, personal guarantee
- Examples of Current Providers of a Bank Overdraft: All banks
Inventory finance is financing which is provided to allow a business to purchase their inventory with repayment being made once the product has been sold to the end customer. This kind of finance can be particularly useful when a business is starting up as it can be used to fund the initial purchase of inventory.
Typically, with this kind of finance, because the assets will not be staying in the possession of the lender, the financier will require a personal guarantee from the directors of the company.
- Advantages of Inventory Finance: Allows for purchase of inventory.
- Disadvantages of Inventory Finance: not available to all industries, interest charges accruing during production process.
- Examples of current providers of inventory finance: most major banks, although this often limited to particular industries.
Family, Friends and Fools
Borrowing from friends, family or fools (FFF) is attractive for a number of reasons. The main reason is that FFF’s are unlikely to require security or to charge a high rate of interest. FFF’s are also not in a position to run credit checks or to carry out due diligence on the assets of the business. FFF’s are also unlikely to understand the risks involved in making the proposed loan.
Rather than taking on debt, one strategy is to ask a FFF to invest in the business and in return give them shares. This has the advantage of meaning the business will only need to pay the FFF if it is making a profit and paying a dividend.
However, funding from an FFF is not available to all and may impact adversely on personal relationships if a company faces financial difficulty.
- Advantages of Friend, Families and Fools: Low interest, limited credit checks, unlikely to require security.
- Disadvantages of Friends, Families and Fools: Potential negative impact on close personal relationships.
Residential mortgage finance
Residential mortgage finance is finance provided in return for security granted over property. Some businesses have sufficient property of their own to secure borrowings, but if a business has limited assets, lenders will often require a mortgage over the real property of the directors. As with a personal loan, this should be avoided if possible as it increases the risk of personal loss to the director if the business is unsuccessful. There is also a danger to the director’s family as their home may be in jeopardy of repossession if the business fails.
There is one very significant advantage of a loan secured by residential property. These loans will generally attract the lowest rates of interest with some finance currently available at interest rates approaching 5% per annum. This rate of interest is very low historically with mortgage interest rates when compared to other forms of finance.
- Advantages of Mortgage Finance: Low rate of interest.
- Disadvantages of Mortgage Finance: Puts personal assets at risk.
- Current providers of Mortgage Finance: All banks.
Peer-to-Peer (P2P) Lending
P2P lending is a new platform for lending that uses online platforms to connect individual non-bank lenders to borrowers. Morgan Stanley has predicted that by 2020 the P2P lending to businesses in Australia will increase to $11.4 billion.
P2P lending is attractive to small business lenders as these platforms will often require less paperwork from borrowers. P2P lenders will also place less onerous conditions on a loan than a bank will. The interest rates are typically between 10-15%, but can vary substantially because platforms have a competitive bidding process for a borrower’s loan. The term of the loan can range from 6 months to 5 years, with loan amounts available ranging between $2,000 and $2,000,000.
One potential downside for borrowers is that, at present, P2P lending is a lightly regulated section of the market, and as such there is potentially more scope for unethical behaviour. There is also frequently a loan application fee which must be paid, with no guarantee that the loan will be made. Some P2P lenders will also only offer financing for certain things, for example ThinCats Australia will only provide funding for business growth.
- Advantages of P2P Lending: Gives access to alternate sources of funding, speedy application process, Limited security needed, and competitive loan tender process.
- Disadvantages of P2P Lending: unregulated industry, relatively high rate of interest, ancillary charges.
- Current Providers of P2P lending: Thin Cats Australia, Marketlend.