Sources of small business finance
Even the most cash-generative companies need funding to either start or grow. Regardless of how much money you're able to put in yourself, it's important to step back and consider the business finance options open to you.
Typical small business funding comes from either friends and family or banks, but there are actually a range of business finance solutions available.
So before you rush to the bank, have a read of the following:
Why raising finance is important
- If your company needs to grow quickly to accommodate demand and make a mark, organic profit revenue may not cut it.
- If you encounter unforeseen difficulties - delays with suppliers or late payments from clients - a financial cushion could save your business.
It is vital you select a source of small business financing that doesn't just provide the capital you need but has repayment terms to suit your growth and which you, as an individual, are comfortable with. The type and size of investment you seek will depend on the stage your business has reached. This guide looks at your options: explore all those open to you:
- Personal investment
- Grants and government support
- Private equity
- Asset-based finance
- If you are passionate about your business idea and confident it will succeed once it's on its feet, you should be ready to put some of your own savings into the venture. Not only is this the most natural first step, it can also make good business sense. You are more likely to push your business forward if your neck is on the line.
- You are likely to interest investors more too, if they see you are fully-invested yourself. Just remember to treat a personal investment just as you would that of an outside investor: re-mortgaging your house and throwing in your entire life savings while hoping for the best is not a sound business decision.
- A popular option - if you don't invest your own money directly in the business - is to take no salary from the business and live off your savings instead.
- There are other options besides putting your own money into the venture, of course. You could consider calling on the 'three F's', for instance: Family; Friends - and Fools, so it goes. It's a good idea to make a formal rather than a verbal arrangement, determining whether your family member or friend's money serves as a loan, or as an investment for instance.
- Tread carefully, as misunderstandings can damage relationships: it's only advisable if your business is primed for strong, consistent, growth.
- That said, the three FFFs are usually by far the most affordable form of small business finance out there - and, providing you're successful, arguably the most hassle-free form of investment for those investing too.
- See Business Link for further legal, tax and general considerations on the three F's.
- Strike a balance: invest personally in your business, but leave yourself room to exit in case it doesn't go as expected
- If you can get funding from a bank, it means you will have more control over your business and determine how fast it can grow.
- Positives in banking:
- Loans come in all shapes and sizes: there will be one that's suited to you
- Credit and pre-agreed overdrafts provide welcome safety nets
- Negatives in banking:
- Beware of high interest rates, especially when considering credit cards: look into fixed-rate and capped-rate loans
- When setting up an account, applying for a bank loan, or for credit cards or an overdraft, it's important to have an excellent business plan prepared. You need to show that your business is ready for investment and you should also have clear sales projections and a robust cash-flow forecast. Our guide on how to apply for a business loan will help.
- It's worth considering offering personal guarantees to secure the loan, if you have personal assets.
- If you are finding it difficult to secure credit, you are well advised to look into the Enterprise Finance Guarantee (EFG) scheme.
Ready for a business bank account?
- There is a wide variety of business grants available: they are available from the government, from your local authority, from your regional development agency, and from the EU.
- Grants aren't available for all businesses though - the EU's grant activities are limited to public sector funding, for example - so before applying, make sure to check your eligibility.
- Be prepared for a complicated application process.
- Areas where grants proliferate include research & development (R&D); employment and training; and environmental schemes.
- Business Link's Grant and Support Directory is a great place to check whether there is a grant out there for your company.
- If the application process deters, you can contact your local Business Link for help with your application, or it's possible to hire a consultant to help you with the grant application process. As many grants are awarded on a competitive basis, this is an option worth considering: it may raise your chances against other applicants.
- Remember to research eligibility criteria and consider hiring a consultant
- Business angels and Venture Capitalist (VC) firms provide investment in exchange for a share of your company. While this means you'll be giving up a share of your business - and therefore the profits - the backers will also give you their expertise and help you generate new contacts as well as supporting the management of your business.
- It's likely there will be a planned exit identified, at which point the investors will expect to have realised their return.
- Generally, for a business angel to be interested in your proposition, your business should have the potential to grow exponentially over the next three to five years. Angel investors look for a good return on their initial investment - of up to £750,000 - after a three- to seven-year holding period, and the average return on angel investments in the UK is 22% after four years.
- Venture Capitalists are generally interested in specialised areas and high-growth businesses looking to raise between £2m and £5m. It's worth bearing in mind, while VC's have larger cheque-books, they also take a larger percentage - a minimum of 20% -- of your business, and take a very pro-active role in your company. In contrast, Angels tend to take a more supportive role, but once they have invested, both VC's and Angels expect results.
- Be prepared for a change in dynamic once the business changes from your 'baby' into a full-grown firm with a board of investors calling your decisions into account - it's a very different set-up.
- Log on to the British Business Angel Association to find investors and attend networking events
- Asset finance allows you to secure a loan for an asset - a piece of machinery, or a car, for example. Such an agreement effectively means you rent the machinery from the lender until you have paid off your loan.
- The advantage is you can spread your cost against the productive lifetime of your purchase.
- You need to make sure you demonstrate your business can afford the asset, and try to show how securing the loan will support your business' growth.
- Asset finance can spread out your costs but beware: such a loan can be accompanied by high interest rates
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