Be it for growth, operations, or tackling unforeseen challenges, securing funding is a critical component for any business, particularly small and medium enterprises (SMEs). Two key sources of commercial funding to be across are traditional bank loans and private credit. Understanding the differences between these options can help you make informed decisions that best suit the financial needs and objectives of your business.
Bank Loans: The ‘Not-So-Private’ Credit Option
Venturing into the world of traditional bank funding can often feel like navigating a robust but somewhat rigid terrain. It's a well-worn path that many businesses take to secure capital, but it comes with its own set of rules and procedures.
Bank loans are typically characterised by lower interest rates compared to private credit, making them a cost-effective solution over the long term. However, to qualify for a bank loan, businesses must demonstrate strong financial health, stable cash flow, and a solid credit history. The application process can be lengthy and involved, requiring comprehensive documentation including financial statements, tax returns and ATO history.
From application to fund disbursement, the process can take several weeks to months due to detailed assessments and approval procedures, but on the plus side, lower interest rates lead to reduced overall borrowing costs, and banks are regulated entities, offering a degree of security and reliability. On the downside, the detailed documentation and approval processes can be time-consuming, and small businesses or those with less established credit and historical financial performance might find it challenging to qualify.
What is Private Credit?
Private credit (also known as private debt) occurs outside traditional bank lending or public debt markets. While private credit covers a wide range of lending strategies, such as funding for acquisitions of distressed assets, it is most commonly used in direct lending to large and small organisations.
Is Private Credit Funding Right for Your Business?
Tapping into private credit is akin to exploring a flexible yet more expensive and risky alternative. It's a relatively swift avenue where loans are provided by private credit firms and funded by private credit fund investors seeking high investment yields . Due to needing to satisfy their investors, private credit often comes with higher interest rates than traditional bank loans. These high interest rates also reflect the increased risk taken by private lenders.
Private credit focuses more on asset value and expected returns rather than stringent credit histories, and the documentation requirements are less cumbersome, making the application process more straightforward. Funds can be accessed much quicker, often within days, making it ideal for urgent financial needs.
Private credit lenders may offer more customised loan terms suited to the specific needs of the business, and it is more accessible to businesses that may not meet traditional bank loan requirements. There is also potential to seek a second mortgage against a property, typically at an interest rate of 15-20% per annum, offering businesses a flexible loan solution without severing ties with their primary bank.
Private Credit vs Bank Lending Cost Comparison
To illustrate the cost differences, let's consider an example of a $500,000 interest-only repayment loan over a 24-month period with the following assumptions:
- Private Credit with a 10% interest rate and a 2% establishment fee ($10,000)
- Bank Loan with a 7% interest rate and a 0.75% establishment fee ($3,750).
Pure interest costs over 24 months amount to $100,000 for private credit and $70,000 for a bank loan. Establishment fees are $10,000 for private credit and $3,750 for a bank loan. Over a two-year period, the cost difference is $36,250.
Risk Considerations Around Private Credit Funding
An important consideration with private credit is the possibility of incurring higher costs in case of default. Missing a payment with a private lender can lead to the interest rate escalating to 15-20% until the arrears is cleared.
Private lenders are also not as tightly regulated as banks, leading to possible risks in terms of reliability and transparency. Loans are always secured against significant assets such as a borrower’s home or property, posing significant risks if the business defaults.
These are critical factors when considering traditional bank/lender funding for commercial purposes vs private credit options. Where the path to losing your property with a bank is long and will involve genuine support from the bank to ensure it hopefully doesn’t get to that stage, there is far less time involved with private credit, and they will not hesitate to call upon a property if a borrower is defaulting on payments and their investors aren’t yielding the returns that were advertised.
The Final Call on Private Credit vs Traditional Bank Funding
Choosing between traditional bank funding and private credit depends on several factors specific to your business, including the urgency of the funding need, the financial health of your business, risk vs reward, and the assets available to secure the loan.
Opt for traditional bank funding if you prioritise lower costs and have the luxury of time to navigate the traditional bank application process (a good business loan broker can assist here). It's ideal for businesses with strong financials, current bank relationships, and a sound credit history.
Consider private credit if you need quick access to funds, have less-than-perfect credit, need flexible loan terms, and have the utmost confidence that you can repay the debt. This option suits businesses that can handle higher borrowing costs in exchange for faster approval and funding.
Need Help Securing Funding for Your Business?
When you need funding to grow your business, solve cash flow challenges or ensure operational stability, BlueRock Finance is your first port of call. Whether you’re able to secure a bank loan or need to look at alternatives such as private credit, we advise and assist clients to review the details with their accountant and financial advisor , and have any documents reviewed in detail by a solicitor to ensure all obligations and costs are understood in full.
Reach out to our experienced business loan experts via the form below.
