Fortunately, there’s a vast array of options when it comes to raising capital, from debt, to equity and beyond. This guide will take you through all the major sources of funding available to businesses in three key sections:
Debt financing is a way of raising capital through borrowing funds. It’s referred to as debt finance, as the borrower must pay back the funds at a later date.
Debt finance can be a good option for businesses seeking funding to support growth its also usually tax-deductible which doesn’t hurt. The main downside is that lenders charge interest, meaning you have to pay back more than was initially invested – depending on the interest rate the sum repaid may be far larger than the initial loan.
This obligation makes it a riskier way of raising capital, this is why early stage businesses don’t opt for debt financing. Below you’ll find the key forms of debt financing available to businesses.
1. Business loans (secured)
Secured business loans are secured against assets owned by a business, such as commercial property, vehicles or machinery. Using assets to secure a loan means that the company director doesn’t have to put themselves on the line by personally guaranteeing the borrowed funds (you might also further look to protect directors against other risks through Directors’ and Officer Liability insurance).
With a secured loan, if you can’t repay the borrowed money, the lender has the right to sell the asset/s in question to get their funds back. Secured business loans are a way of unlocking cash tied up in your business assets, using them as security in return for cash.
If you’re a company with high value physical assets, you’re likely to be readily accepted for a secured business loan. Owing to the reduced risk for the lender, this type of borrowing also tends to be a cheaper form of lending versus other options.
It’s important to remember though that secured loans mean your assets are at risk if you fail to repay or miss payments. If you come into financial difficulty, the lender can usually seize and auction your assets. If your asset is your warehouse, essential to the business’ daily operations, that could mean the end of your company.
2. Unsecured business loans
An unsecured business loan does not involve any security or collateral. Instead, lenders judge whether or not to lend based on your company’s ability to repay the loan. They do however often ask for a personal guarantee from a company director to repay the loan if the company defaults (this is also common with overdrafts). Typically, applying for an unsecured business loan involves a deep check into your credit history, income, savings and employment.
Unsecured business loan have the advantage that you don’t have to put up anything as collateral, which means it is open to businesses without physical assets. There are also typically no restrictions on how you spend the borrowed money.
However, interest rates tend to be significantly higher on unsecured loans, due to the higher risk for the lender.
3. Commercial mortgages
Companies looking to invest in land or property for business purposes, often turn to a commercial mortgage as a source of debt finance. This product is basically a mortgage but instead of an individual the company borrows money secured against the property purchased or owned (it’s not uncommon for businesses to mortgage commercial property later on to free up capital).
A commercial property mortgage tends to be a long-term loan between 10 and 25 years. Commercial mortgage lenders typically lend between 60% to 75% of the value of a property. The loan is repaid monthly as with a standard mortgage charge including interest, unless otherwise agreed (some insurers offer quarterly payment schedules).
There are several key benefits to using a commercial mortgage as a source of business funding. Starting with value, if you’ve made a wise commercial property investment an increase in the value of the property may end up outweighing the mortgage (you are however at risk from a drop in value).
Instead of losing money to rent an office or factory space, by purchasing and mortgaging a commercial property you are building long term equity. You also have the option to sublet or lease unused space with your property to make extra income.
Most commercial mortgage providers will however require a substantial deposit to secure a mortgage, usually between 25% and 40% of the price/value of the property (unless you already own it in which case you can often release 100% of the equity via a commercial mortgage).
Companies should also factor in the extra expenses that come with owning property as opposed to renting, such as building repairs, security, insurance costs as well as responsibility for the fixtures and fittings.
4. Asset financing or leasing
Asset financing is a way of quickly accessing a loan that is secured against a high value asset or assets (either to purchase or release equity).
The borrowing company uses its balance sheet assets, such as short-term investments, accounts receivable, machinery or even buildings as collateral to borrow money.
Typical forms of asset finance include equipment leasing, hire purchase, finance leases, operating leases, asset refinance and invoice finance (detailed later on as it differs to traditional asset finance in function and process).
Companies mostly use this form of finance to acquire high value equipment. Typically, this process works via the asset finance provider buying a capital asset that the company needs, with the company agreeing to paying for it in instalments with interest (similar to secured loan).
It’s also common for companies to release cash from existing equipment by selling it to a finance provider and leasing it back from them instead, known as asset refinance.
Asset finance is a preferable form of financing for many businesses and lenders, as it is based on the assets themselves which provide security for both parties. It’s often more flexible and cost-effective than getting a commercial bank loan to purchase equipment and tends to be a quick way for companies to access the capital, resources or equipment they need.
However, it is important to note that it’s a more expensive way of buying an asset than purchasing it outright. On top of that, if you default on a repayment, you could lose the ownership of the asset.
5. P2P lending
Peer to peer lending allows businesses to borrow money through online platforms which match lenders with borrowers. Peer-to-peer lending companies tend to offer their services more cheaply than traditional financial institutions, which enables lenders to earn higher returns and borrowers to borrow funds at lower interest rates. Some P2P websites allow lenders to choose who borrows their money, while on others the money they lend out is divided between lots of borrowers.
P2P lending hugely simplifies the borrowing process. It’s far easier for many businesses to find funding than going down a more traditional route, such as through a bank. Many companies can receive funding within just a few days through a P2P site, or even a few hours. P2P loans are also typically more affordable than other forms of credit or finance.
The biggest downside to P2P lending is the increase in risk. Without restrictions in place and thorough credit checks imposed by banks, many companies borrow more than they can realistically afford, putting them at financial risk. What’s more, many P2P lenders only permit loan-to-value ratios, usually around 65%, which means companies need to find other ways of supplementing their loans.
6. Overdraft financing
Using a bank overdraft is a way for companies to obtain short-term funding. In essence a company agrees on an overdraft limit with the bank, known as the ‘facility’, and the bank charges interest on the amount of the overdraft the company are using (overdrawn). Some banks also charge an overdraft facility fee. Often overdrafts require a director guarantee and assets put up as collateral for larger overdraft facilities.
Most businesses use overdrafts to offset cash flow issues, where the business is healthy but because of outgoings/income coming at different points throughout the month, an overdraft facility is need to pay bills.
Overdraft are typically an easy, quick and flexible way for businesses to borrow money in the short term. Businesses only pay interest when they are overdrawn, and they can review and adjust the overdraft facility limit with the bank.
However, overdraft interest rates are typically higher than business loan interest rates, so it may be worth considering other forms of finance for anything other than balancing cash flow. Most business banks also charge an overdraft fee to keep the facility in place, even if you aren’t using it. Finally, the bank could rescind your overdraft at any time.
7. Business credit cards
Commonly used as an alternative to an overdraft, a business credit card allows the owner to pay for items such as supplies or equipment and pay the cost at a later date. Credit card companies will typically charge a standing fee and agreed interest on purchases, some however have an interest free period or 30 or 45 days, which can be extremely attractive.
Using a business credit card responsibly can also go a long way to building your business credit, which can help your company secure a bank loan in the future. Many credit card companies also offer purchasing incentives to businesses such as airline miles, cashback or other perks.
It’s also important to know that most business credit cards require a personal director guarantee, which can have an effect on your personal credit rating, and may mean that you become liable for late credit. They’re also typically expensive, as interest rates are high beyond agreed periods and there are several fees, such as maintenance fees and late payment fees (many businesses and individuals fall into this trap, it’s worth considering setting up automatic payments will pay anything owed on your credit card monthly).
8. Hire purchase
One of the more popular forms of asset financing is hire purchase, this is where a finance company buys an item that you need, such as a piece of equipment and you pay monthly instalments with interest to purchase ownership over the equipment over time. Asset ownership is transferred to your business once all payments have been made. It’s ideal for any company that needs immediate use of expensive equipment to grow that they cannot afford.
It’s advantageous for companies as they don’t need to raise capital for the full amount, meaning they can make essential purchases quicker. Spreading the cost out over time often also allows companies to opt for newer, better equipment than they would otherwise be unable to afford.
The drawbacks are that the items can be repossessed if you default on payments. This reduces the risk for the financer but can mean the end of your business if the asset is essential to ongoing trade. Defaulting on a hire purchase payment will also harm your company’s credit score.
9. Trade credit
Trade credit can facilitate business to business transactions to go ahead even if the purchasing company doesn’t have enough working capital available for the trade, these type of facilities are often protected by trade credit insurance.
With a trade credit agreement, business customers can buy goods or services from their supplier and pay for them later on (typically 30, 60 or 90 days). Trade credit is particularly useful for smaller businesses or companies who struggle to reconcile the timings of their cash in and cash out and need to purchase stock to grow (it’s also worth exploring stock insurance to protect your assets/debt obligation).
However, trade credit is notoriously risky and many suppliers will not offer it. While it can be invaluable in driving short-term growth, allowing companies to purchase goods and services they need to grow before they have the cash to hand, puts the supplier at serious risk if something we’re to go wrong.
That said, there are some attractive benefits to using trade credit. It makes business-to-business transactions far easier, allowing the business to align their payments with their outgoings and access resources they need when they need them. It also promotes growth for both parties and is far easier to obtain than traditional forms of funding such as a bank loan, as your dealing with a trusted supplier. The flexibility of trade credit can also go a long way to establishing positive, loyal relationships with clients.
10. Invoice finance
Invoice finance involves companies selling their individual unpaid invoices or entire accounts receivable, to a third party for a percentage of their value, usually around 80-95%. This method of finance means that, for a fee, businesses can unlock cash tied up in unpaid invoices, accessing the funds before the customers pay.
It’s a type of business funding often used by companies that work in trades where customers have extended payment terms of 30, 60 or even 90 days. When the customers pay, the lender receives their money, and the business gets its remaining 5-20% of the invoice, minus the fee.
There are two main types of this type of finance being invoice factoring and invoice discounting. They work broadly the same way, except that with invoice factoring, it is the finance company that deals with collecting the debt from the customers.
With invoice discounting, you retain control of your customer accounts, and it’s down to you to chase late payments. For companies that only need help to bridge their cash flow gaps due to one or two customers, its preferential to opt for selective invoice discounting, rather than commit to a contract for their entire sales ledger.
The main advantage of invoice finance is that it steadies your cash flow. Getting a large portion of your invoices paid straight away boosts your working capital, allowing you to purchase more materials, accept more jobs and grow your business without having to wait. It can also be confidential if you choose, which protects your customer relations, as they won’t know that you’re using invoice finance.
Invoice finance does come with some disadvantages. The main one is the price, as invoice finance remains one of the more expensive ways to finance a company. It can also have a negative impact on a company’s reputation, as customers tend to perceive companies that factor their sales ledger as less stable and potentially high-risk suppliers.
11. Merchant cash advances
Hailed as one of the most innovative forms of business finance, merchant cash advances is one of the newer funding options out there. It works by using your business’ card terminal transactions to secure lending, the amount borrowed is then automatically paid back at an agreed rate plus interest on each future transaction. It is ideal for companies that process a substantial amount of card transactions every month.
It’s become a quick and efficient funding solution for many small and mid-sized enterprises, particularly in the retail and leisure industries. One of the principal advantages of this sort of finance is that it’s both flexible and scalable. Repayments tend to represent a percentage of the company’s revenue, meaning they’ll go up and down proportionally with the business’ fluctuating income. It’s also easy to repay the money. The lender communicates directly with the card terminal provider, meaning that the amount they take for repayments never appears in your business bank account. The payment is taken automatically, so the business owner need not worry about making the repayments.
However, like any source of business finance, it’s not without its downsides. First off, you can only borrow funds in line with how much your business makes. The general rule of thumb is that you can receive a merchant cash advance equivalent to what your business accepts in an average month, which makes it impractical for borrowing substantial funds in comparison to a business’s annual revenue.
It’s also only really useful for companies who take the majority of their payments via the card terminal, rather than those who also accept cash or bank transfers. Many lenders only work with specific terminal providers, too, which can limit your options.
12. Start-up loans
Launching a business can be hugely expensive. You’ll need to pay for equipment, marketing, payroll, rent, as well as a mountain of other expenses. One way for fledgling businesses to secure a substantial initial investment is through a start-up loan, a government-backed personal loan available to entrepreneurs looking to start a business in the UK. Many private companies offer a similar loan, too.
Start-up loans are unsecured, meaning you don’t need to put up any collateral. Successful applicants to the government programme will also benefit from 12 months of free mentoring in addition to finance. Each applicant can apply for up to £25,000 (maximum £10,000 on the first loan).
The loans can be a massive help for start-ups looking to get their hands on enough capital to get their venture off the ground but who lack track record most lenders would require. However, there are some things to consider. The loan must be paid back within one to five years, and you are personally liable for repaying the loan even if your business direction changes.
There are also several restrictions about what you can and can’t use the loan for, with exclusions such as training qualifications, education programmes and debt repayment.
Equity funding is where businesses raise funds by selling ownership shares to an investor/s in exchange for capital. The principal difference between debt finance and equity funding is that entrepreneurs using equity funding are not required to pay the funds back. Below you’ll find a breakdown of the most common forms of equity funding.
13. Venture capital
Venture capital investors are professional investors who manage and invest funds for wealthy individuals’ investment banks or other financial institutions. Venture capital investment is classed as high risk private equity investment and VC funds make up about 10% of all private equity funds.
Venture capitalists are looking to invest in high growth potential companies who are typically technology based, popular examples of VC backed companies include Uber, Deliveroo and SimilarWeb. The VC model aims for every 1 in 10 investments to succeed and make such a return that it dwarfs the loss from other failed investments, the average VC operates on a 2:20 rule, meaning they take a 2% management fee each year on the total fund capital and 20% of the upside if a company is able to sold.
Venture capital can be a fantastic way to grow a company fast, with venture investments raning from £500K to £100 million in some cases. Venture capitalists also tend to have vast amounts of expertise that can help accelerate a company, they can offer contacts to support your business.
While there are multiple benefits, finding a venture capitalist investor can be long process. For those who successfully raise venture capital, it normally takes 3-9 months to raise and close a VC round. Bear in mind that the majority of businesses will fail to raise VC funding and VC’s will typically seek additional control via draconian investment contracts and by taking board seats as part of any deal.
14. Angel investor
Business angels (angel investors) are wealthy individuals who use their own funds to invest in the companies they see growth potential in. Angel investment tends to range from £30K up £250K, it is often the first source of investment funding a start-up will secure before moving onto a venture capital round. Aside from the investment capital provided, business angels can also bring invaluable industry knowledge, expertise and contacts, which can help you grow your business in its early stages.
Perhaps the world’s greatest angel investment to date is Google. What began as a university graduate research project became a multi-billion-pound corporation with the help of a staggering investment of $250,000 by Ram Shriram, an investment which is estimated to be worth around $2.5 billion (around £2 billion) today.
15. Equity crowdfunding
Equity crowdfunding is the process of sourcing small investments from a large number of investors via a platform that facilitates the investment. Crowdfunding has grown in popularity in recent years making it’s easier for high-risk early-stage businesses to gather together the funds they need to get off the ground (and now even more developed companies looking to carry out funding rounds).
Crowdfunding also offers more visibility to businesses looking for investment, enabling them to connect with investors all around the world. This visibility also works as valuable marketing and allows you to measure the public’s reaction to your product or business idea. It’s also an excellent option for those who have previously struggled to secure bank loans.
There are several disadvantages to crowdfunding. First of all, not all projects that apply to crowdfunding platforms are accepted onto the site. Secondly, if you do reach the site but don’t reach your fundraising target, any pledged funding is typically returned to the investors.
16. Angel syndicate
Another way to secure angel investment is through an angel syndicate. Business angels invest together as part of a syndicate (group of angels), which reduces each investor’s risk. Sharing the load also means that investors can maximise their investing capacity, to pool funds with others to invest in even higher-potential early-stage businesses. Angel syndicates can, therefore, help early-stage enterprises to secure a substantial investment.
Acquiring funding through an angel syndicate means you can benefit from higher amounts of capital. Syndicates tend to constitute at least three investors, which also means triple the industry knowledge and triple the guidance for your venture.
17. Private equity
Private equity is a route typically taken by more mature companies looking for significant funds to fuel new growth. A private equity fund invests in firms on behalf of its investors and then looks to sell its stake several years later for a significant profit.
Most private equity deals are between £400 million and £4 billion, making it one of the best options for multimillion-pound corporations looking for cash to drive serious growth. Private equity firms look for a majority stake in the business, which can allow them to take the reins and turn the company into something more profitable. This can be advantageous for both parties and can help entrepreneurs maximise the value of their ventures.
However, this level of control can also be a drawback for many businesses who want to retain autonomy over the business direction. Private equity firms want to make the company as profitable as possible, as quickly as possible, which may clash with the longer-term priorities of a company’s founder, who might place more value in brand reputation and customer relations.
18. Corporate Venture Capital (CVC)
CVC is where large corporations invest funds directly into start-ups in exchange for an equity stake. The larger firm provides management, industry expertise and marketing power to help the smaller business gain a competitive advantage. Corporate venturing aims to set up collaborations which drive growth for both parties and have the potential to lead to an acquisition down the line, they tend to focus on businesses and technological development that aligns with their business.
A significant advantage of CVC compared to other forms of funding, specifically private venture capital, is the strategic side to the investment. Strategic CVC investments aim to exploit any growth potential in the parent company by breaking into a new market. CVC investments are therefore typically made in start-ups launching new technologies.
CVC Capital Partners, one of the largest private equity and investment advisory firms in the world. They manage $79.6 billion (approximately £63.2 billion) of assets, investing in high-growth companies across Europe, Asia and the Americas.
Alongside these more traditional routes of business funding, more and more innovative ways to raise funding are cropping up for small and large businesses alike.
One of the most attractive ways of raising capital is through a business grant. Grants mean free money to get your business off the ground, with no obligation to pay it back (or matched funding to a certain level). Fortunately, there are an enormous amount of grant schemes open to entrepreneurs and companies in the UK. The government offers a huge number of grant schemes for different types of businesses, of varying amounts. Many charities and corporate also provide grants for projects in certain areas or with specific aims.
While grant schemes are in abundance, there is also, unsurprisingly, a tremendous amount of competition. Awarding bodies tend to look for companies that intend to have a positive impact on society, either by helping people in a community or by boosting the general economy. Other things to consider are that most grants are reserved for companies that intend to have a specific impact on society. Successful applicants will have to justify why they deserve the money, how they fulfil the requirements as well as show exactly how they intend to use the funds.
Another thing to consider is how time-consuming applying for grants can be. Most of the applications are lengthy, and you’ll have to provide a considerable amount of information to justify the purpose of your venture and the direction of your company. It’s worth considering whether the amount of time you pour into applications is worth it if none of them are successful.
There is a vast range of business competitions open in the UK, which can provide funding, resources, training, mentoring or marketing. Many enterprises, charitable organisations and local government-funded bodies offer competitions to individuals with business ideas or small companies looking to grow.
Similarly, to business grants, these are highly competitive, and in the case of monetary rewards, there may be restrictions on how you spend the money. Again, specific awards come with particular guidelines and entry criteria and are usually only open to companies with a specific aim or in specific fields.
21. Tax reliefs
One option to attract business funding is to use a tax relief scheme, such as the Enterprise Investment Scheme (EIS) or the Seed Enterprise Investment Scheme (SEIS). These schemes act as incentives to investors to invest in early-stage businesses by offering them attractive tax benefits if the company and investor comply with specific regulations.
The schemes offer a number of different forms of tax relief, from income tax relief to CGT exemption, as well as loss relief which allows an investor to offset any losses they incur from the investment, which drastically reduces their risk and encourages them to invest.
While the tax relief schemes are effective in encouraging angel investors and venture capitalists, these type of investors come with their pros and cons.
22. Friends & family
One of the most common forms of funding for an early stage business venture is via friends and family, for either an investment or a loan.
There are pros and cons of gathering funds this way. Firstly, it’s far easier and quicker than approaching banks, skipping steps like an arduous application process. As they’re members of your close network, they’re usually more flexible and will charge low interest or none at all. The personal level of trust means you tend to have longer to repay them, too.
That said, there are some significant drawbacks to consider. Money can put a strain on any relationship, and transactions like these can make things complicated between friends or even family. If you lose the money, you may also be putting your loved ones at financial risk.
If you do go for this form of funding, make sure you are crystal clear about your expectations for the loan or investment, how long you need the money, how you intend to repay the funds and what shares or profit the investor will receive. It’s a good idea to draw up a formal written agreement to offer your network some security and to take the pressure off of your relationship by making sure everybody understands the terms of the arrangement.
23. Debenture bonds
Debentures are bonds issued by a company to investors when the company borrows money from them. The debenture serves as a loan, which is repayable at a later date by the borrowing company. The company must pay interest to the creditor during the period of the loan at a fixed rate, which makes it a more stable way of investing in a company than by investing in shares. The critical difference is that debenture holders do not have a share in the company itself.
One of the main advantages for the borrowing company is that debentures tend to provide long-term funds. The fixed interest rate tends to be lower than rates you would pay at a bank or for an unsecured loan. As the bond doesn’t offer the investor a share in the company, the business gets to retain full control and keep all of its profits. A debenture is also secured, which makes it an attractive option for the lender, too.
The main difficulty of this type of borrowing is that the company must pay interest payments throughout the loan period. If the company is struggling, it is still liable to pay its interest. It can also be challenging to find lenders who are willing to invest through a debenture, as many lenders want a stake in the business they’re investing in, as well as voting rights.
Getting hold of enough funding can be the make or break between your business venture taking off or expanding to its full potential, it can feel like an enormous task but whittling down your options can make the process more efficient, and maximise your chances of raising funds.