Credit or overdraft – what is the best approach for a new venture?

Trying to decide whether to fund your startup by loading up the credit cards or applying for a business overdraft is a challenge felt by everyone starting out.

So what’s the right choice for your situation?

A business overdraft can be handy because it offers a flexible source of short-term cash, ideal for managing unexpected costs and fluctuating cash flows throughout that treacherous first year.

However, they’re not easy to come by. Your lender will want to see a rigorous business plan and budget, which can be expensive and time-intensive to prepare, according to independent business banking expert, Neil Slonim, from The Bank Doctor.

“For a business overdraft, you’d be going into the bank, cap in hand and hope you’re seen in a favourable light,” Slonim says. “It can be a daunting process if you’re not used to borrowing money for a business.”

If you do manage to secure a business overdraft, be sure to spend the money wisely, advises Pitcher Partners principal of corporate transaction services Simon Johnson.

“I’ve seen plenty of people get access to an overdraft facility and max it out on expenses that aren’t related to growing the business,” Johnson says. “Every dollar you borrow should be spent making a profit for the business, rather than a shop fit-out or the latest technology.”

For example, hiring an employee able to generate an income, or a marketing campaign designed to build interest in the business is money well spent, he says.

On the other hand, there are far less hoops involved in obtaining a credit card, which is why they appeal to so many startups.

“We all get those letters from the bank offering to increase our credit limit, so it’s just a matter of approaching the bank and applying. If you’ve got a decent credit history, it’s an easy way to get access to borrowed funds,” Slonim says.

The other bonus is that credit card applications are processed a lot faster and sometimes offer 30 days of free credit.

However, the lender will insist that the credit facility is in your personal name, not the name of your fledgling business, Slonim says.

The downside of a credit card is that you could be paying an interest rate of between 14 and 20 per cent, depending on the specials being offered by lenders at the time. This compares to a business overdraft of around eight to 12 per cent, Slonim says.

“There are advantages and disadvantages to both, so you’ve got to consider how quickly you need cash, and what you’re using it for,” he says.

Whichever you choose, be conservative in your assumptions so you’ve got a contingency plan in case something goes wrong, Slonim adds.

For example, if you need $20,000, add a contingency of $5,000, he says.

“And always abide by the bank rules and read the fine print. If you can’t understand the small print, go and see a trusted advisor and seek help.”

Johnson adds that while big dreams are one thing, don’t start out under-capitalised or you’ll never make it.

Startups need to be realistic. A stable income from a job, a partner able to support you, or income from an investment property is an ideal way to pay the bills so you can reinvest back into the business, he says.

“I’ve seen it time and time again. Startups that really thrive are the ones where the business owner doesn’t have to pay the bills out of the money made from the business in those early days,” Johnson says.

Written by: Nina Hendy

This article is sponsored by Australia and New Zealand Banking Group Limited ABN 11 005 357 522 (ANZ).

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