Debt Financing Options for Singapore Companies
Where entrepreneurs and businesses in the seed state are looking for some start-up capital to start their operation, they frequently turn to debt financing to get their company off the ground. Debt financing differs from equity financing in that entrepreneurs retain full control over the business and all profits generated from it, and does not involve selling stakes in the company to investors. Debt financing refers to a system whereby the entrepreneur borrows the money from a lender (usually a financial institution) on the proviso that they pay back the money borrowed (the principal) within a particular time frame at a set rate of interest. Regardless of whether your business is successful, you are obligated to pay back the money. When compared to equity financing, debt financing is far cheaper for successful businesses, but extremely expensive for businesses that do not generate sufficient cash flow to service the debt.
A start-up entrepreneur’s first port of call for debt financing is usually their closest friends and family members, who may provide informal capital in the business’ earliest stages. However, all successful companies eventually outgrow this source of capital, and high-growth or capital-intensive businesses will quickly find this insufficient. It’s here that banks and finance companies become the most important source of debt financing. Over the past decade, Singapore’s banks have developed increasingly sophisticated loan offerings for start-ups seeking debt financing.
Ottavia has prepared this guide to provide entrepreneurs with a broad overview of the private debt financing options available for start-ups incorporated in Singapore.
Sources of Private-Debt Finance
Types of Loans
The majority of retail and commercial banks and finance companies operating in Singapore will provide small business loans to start-ups seeking capital. Small business finance is offered by way of revolving lines of credit, business overdrafts, factoring loans and other methods. Below is an overview of the most common types of small business loans provided by the majority of banks and financial institutions in Singapore:
- Working capital loans: A short-term loan, a working capital loan is taken out to finance the everyday business operations of a company. For businesses in the pre-revenue generating state of their development, a working capital loan helps them stay afloat, paying overheads and purchasing materials. These loans can either be secured (with the debtor providing some form of collateral such as real estate or another asset), or unsecured (without any collateral provided). Generally, only low risk borrowers will be able to access an unsecured loan because of the additional risk posed to the lender. Additionally, secured loans have a lower rate of interest attached. Due to the newness of the business and their short – if existent at all – borrowing history, start-up businesses fall into the high-risk category and are therefore usually only eligible for secured working capital loans. It is important to note that the working capital loans are not suitable for the financing of long-term projects and are designed to meet a company’s short term needs. Working capital loans can be provided in a range of forms, including:
- Factoring loans: Under this system, money is lent to the company on the basis of trade debts – i.e. it is the financing of account receivables. In effect, the borrower sells the account receivables to the factoring agent (the bank or financial institution). The borrower will then be provided with an advance calculated on the value of the account receivables, and your client will then be required to deal directly with the bank for the purposes of settlement. No other collateral is required. Typically, banks provide loans of up to 90 per cent of the value of the accounts receivables or billed invoices. Please note that the bank may charge a fee in the range of 1 to 15 per cent of the gross value, as well as an annual interest rate of between 5 and 8 per cent. Factoring loans offers businesses the advantages of immediate access to capital as soon as they issue an invoice, and it removes the labour cost of chasing up an invoice for payment in the future. That said, you no longer have the potential to receive 100 per cent of the value of the invoice, and some of your customers may react negatively to being forced to deal directly with a bank or financial institution.
- Short term loans: Any loan with a maturity period (the date by which final payment is due) of one year or less is considered to be a short-term loan. Some banks may require short term loans to be secured with collateral. Traditionally used for the purchase of inventory, the payment of wages or outstanding bills, or for some additional cash-flow, they are one of the more accessible loans to start-ups, but will require the company to provide projected financial statements and to demonstrate an ability to service the loan.
- Overdraft: Overdraft is an instant extension of a company’s line of credit with a bank. Signing up for an overdraft facility allows businesses to overdraw on the amount in their account up to a predetermined maximum limit – i.e. a business with an overdraft of S$500 can spend S$1500 when they only S$1000 in their account. Interest is only paid on the overdrawn amount and is usually calculated at 1-2 per cent above the bank’s prime rate. The bank will determine the amount of credit allowed. The key advantage offered by an overdraft facility as a form of short-term financing is that it allows the business instant access to a reserve of cash, especially useful when engaged in activities such as stock turnover or paying of creditors. Depending on the specifics of the agreement with the bank, the overdraft facility will either be secured on the basis of collateral, or unsecured.
- Hire purchase loans: Hire-purchase is a method of purchasing goods whereby a business does not have to provide the cost of the goods as a lump sum – making it ideal for purchasing assets that are non-cash convertible. A bank or financial institution finances the purchase of the goods (usually machinery, plant, equipment, or commercial vehicles) and the business makes instalment payments to the institution over a fixed period of time. Under this agreement, the institution retains the legal title to the financial asset, with the business only taking full possession upon full payment of the last instalment. IN other words, the buyer (hirer) purchases the goods they require (assets) through the payment of a deposit and the borrowing of a loan to cover the cost of the asset. They then make monthly instalment payments to the seller over a predetermined fixed financial period. Interest rates are normally provided on a flat-rate basis (i.e. a fixed rate of interest on the full amount financed for the entire term of the hire-purchase agreement). The length of the financing period depends on whether the machinery or equipment purchased was new or used, but will generally last between four and eight years. Businesses can expect to take out a loan amount of between 80 and 90 per cent of the purchase price or market value, whichever is lower.
Tips & guidance for securing a start-up loan
Your business’ ability to secure a start-up loan will depend on several financial and administrative factors including:
- Possessing a sound business plan – Banks will look favourably on a business that has a financially sound business plan capable of demonstrating the company’s potential to demonstrate successful economic outcomes.
- Sales revenue – A higher turnover can only increase your chances of securing the loan quantum your business needs.
- Projected net profit – Your ability to attract short-term working capital loans from banks will largely depend on your expected net profits.
- Paid-up capital – A higher paid-up capital demonstrates an increased commitment to the business from shareholders and directors and as such will increase your chances of obtaining a bank loan.
- Inventory – An inventory comprised of a smaller number of finished goods is likely to be looked on favourably by the banks as it means that a smaller amount of the business’ capital is locked up.
- Start-up owner’s character and credibility – Your reputation as a businessperson, your credit history and the integrity you’ve shown in past business dealings go a long way to helping you secure the financing you need from the banks.
- Collateral – Your ability to provide collateral and your capability to repay the debt will greatly affect the type of loan provided by the bank, and whether or not they decide to provide a loan in the first place.
- Economic conditions – Your industry’s own outlook and the outlook of the Singapore economy as a whole, as well as entry barriers, currency risks and the susceptibility of the business to changes in the external environment will play a significant role in helping the bank determine whether or not to grant you a loan.
- Debt-equity ratio – The majority of banks will assess the debt-to-equity ratio of your start-up – i.e. the amount of money you have borrowed vs the amount of money you have invested into the business. The amount borrowed must be realistic and should be a fraction of the capital – the precise size depending on the nature of your industry and business – that has already been invested.
- Loan application – The loan application is a crucial document for any business seeking a business loan. The application must detail the nature of the loan that you are seeking, including the loan type, the quantum, how you intend to spend the loan, how you plan to repay the loan, and how critical the loan is to the continued operation of your start-up. Details such as a description of your proposed business activities, the background and experience of the management team, information on the market(s) you operate in, financial projections for your business and information about potential collaterals must all be included.
- Friends and family are some of the most common – and in many cases, the primary – sources of private debt financing for start-up entrepreneurs.
- Friendship loans have a number of advantages, including:
- No collateral is required – however this may change depending on the nature of the relationship between borrower and lender;
- The terms of the loan are flexible and may be subject to change;
- The loan period, repayment schedule, and other factors may be open to negotiation as circumstances change and require the mutual agreement of both parties.
- While the loan agreement is rooted in trust and based on verbal assurances, it is advisable to both parties that you draw up a loan agreement, detailing the terms and conditions of the loan to help prevent future misunderstanding, and to provide a written record on which to base the business relationship.
- Entrepreneurs are advised to keep lenders informed about the progress of the business, and to provide a business plan at the outset of the loan. Lenders are sure to appreciate you treating them as a colleague, so providing them with the same documentation and updates you’d offer a formal lender is always a good idea.
- Don’t immediately rule our friendship loans as a source of income – many successful Singapore start-ups were funded in their initial, vulnerable stage through capital provided by family and friends.
Companies that can demonstrate a strong and reliable ability to repay a business capital loan in a timely manner will it extremely easy to secure a loan with extremely favourable terms from a majority of the banks and finance companies in Singapore. Entrepreneurs are strongly advised to approach banks and finance companies well ahead of time, as the process of reviewing a loan application can take several weeks. Bear in mind that start-ups are considered to be a client-type with a high-risk profile, and many banks will be wary of providing a loan due to each start-up’s small capital and limited cash-flow. Entrepreneurs should prudently shop around for banks aligned with your goals offering loan products that meet your needs, and to carefully prepare your loan application to minimise the chances of rejection.