When you’re looking to start or expand a business, there is always one major barrier: money. So the question is, how do you raise the finance needed to fund your endeavour? With a good deal of research is the general answer, but with the popular finance options listed and explained in detail below, we hope to make your journey to finding and securing finance a little easier.
1. Business loans
Business loans typically allow you to borrow an agreed sum of money and pay it back over a certain period with interest. There are two major types of loans:
- Secured business loans: The borrower of the loan puts up some collateral such as a house, car, or shares against the value of the loan. If repayment fails, the asset can become forfeit to the loan provider.
- Unsecured business loans: The borrower of the loan doesn’t put up any collateral, the loan is given based on the borrower’s current situation.
Business loans are generally seen as a source of finance for the medium to long-term. Typically, loans are advantageous as there are many options available, both commercially and government-backed (like the startup loans scheme). You’re not selling equity in your business like with venture capital, and you can shop around for an affordable payment rate and plan. For companies in the UK, there are also some tax benefits on paying back a loan.
If you do take out a business loan, make sure the payment terms and timeline is realistic for your situation and gives you some room if things don’t quite go to plan. Loans remain the most popular option for businesses starting out and one of the most popular finance options for companies looking to expand.
If you are applying for a loan, the primary requisite is that your finances and accounts are up to date, and you have a clear plan to pay it back. Of course, depending on the loan provider, there can be many other prerequisites such as monthly revenue, credit rating, years trading, etc.
2. Invoice finance
Invoice financing allows companies to borrow money against the value of invoices due from customers. There are two primary forms of invoice finance, being invoice factoring and discounting. Typically you can receive up to 85% of the value straight away and the remaining amount (minus the finance charge) when the customer pays the invoice.
Invoice finance can be a great option if you have many corporate or SME customers who have long payment terms or tend to pay as late as possible. It’s a great finance option for plugging holes in cashflow. Your invoice is generally bought as debt in most cases; it’s common practise that if the invoice isn’t paid, you will be shielded from any debt owed.
Although this is an excellent option for finance, invoice financing is only available to companies with a strong track record of generating revenue and getting paid by customers. It’s designed to alleviate the problems that come from 30, 60, 90 or more day payment terms agreed with customers that can cause finance shortfalls.
If you’re looking to gain invoice finance, you’ll need up to date financials and accounts, and your customers will typically need to be reasonably large for anyone to finance your invoice.
3. Business overdrafts
A bank overdraft is an ideal source of finance for the short-term. An agreed overdraft lets businesses use their current account to make payments which exceed their available balance. In other words, the company owes the bank money when the balance goes below zero.
You can borrow anything up to an agreed limit, known as the facility. Companies can negotiate different amounts with the bank, depending on their need and credit history. Some banks charge an overdraft facility fee, in addition to the interest charged on the overdrawn credit. For a larger overdraft facility, banks may require companies to put up security in the form of tangible fixed assets, or a personal guarantee made by the company’s director.
Overdraft financing is useful when a business struggles with timely cash flow. Overdrafts are particularly helpful to cover short-term cash flow shortages from seasonal activities. Banks tend to review overdrafts on an annual basis.
Given the high-interest rates, overdrafts should not be a permanent source of finance. Banks can revoke an overdraft at any time and demand full repayment of the owed funds. For a more permanent solution, consider a bank loan.
4. Business credit cards
Another similar source of short-term business finance is a business credit card, which is the most commonly used finance source for small businesses. Companies can use the credit card to pay for any business-related expenses and won’t incur any interest, provided the outstanding balance is paid off by the end of the credit-free period, usually 30-56 days later.
If you don’t pay the balance within the credit-free period, you’ll accrue interest on the outstanding credit. Each card offers a different credit limit, which puts a cap on the amount you can borrow, typically up to £10,000.
A business credit card is incredibly useful for new startups as it massively increases a company’s purchasing power. In the short-term, the credit is completely free. However, it can be hard to keep track of credit card spending, which can damage your credit. If you don’t manage to pay off the funds owed each money, you can start racking up considerable debt with sizeable interest rates.
Using a credit card responsibly is also an excellent way to build a positive credit report for your company, which is useful for securing loan funding later down the line. While it’s a fantastic source of instant finance, they should be reserved for temporary short-term use.
5. Startup loans
Entrepreneurs can make use of a startup loan to fund their new venture. This form of finance is a personal loan backed by the government, available to individuals looking to start or grow a UK-based business. Not only do successful applicants secure funding, but they also receive 12-months business mentoring, completely free.
Startup loans can offer up to £25,000 of borrowed credit for individuals starting a business. The loan has a competitive fixed interest rate per year and offers a repayment term of 1-5 years.
This source of funding is one of the most attractive available to startups, offering a considerable amount of finance, coupled with valuable expertise. You can apply on the government website provided that you’re 18, based in the UK and your business has been trading for less than 24 months.
6. Merchant cash advance
Any business using a card terminal to accept payments from customers can secure merchant cash advance from lenders through their terminal provider. The terminal provider can see exactly how much money is flowing into your business, and the lenders provide funds in exchange for a percentage of the company’s daily credit card income. This visibility acts as security for the loan; you’ll agree on a loan amount and repayment plan based on your average monthly profit and your cash flow.
Repayments are usually made as a percentage of revenue, meaning they remain proportionate with your business’ income. Such an arrangement works well for businesses without a stable income, such as seasonal businesses. As the card terminal secures the lending, there’s no need for any assets to back the finance, which is perfect for many SMEs.
Generally, you’re able to secure finance equivalent to your monthly revenue. If you’re making £2,000 per month, expect to secure £2,000 in merchant cash funding. The repayment structure tends to have a shorter repayment term than other sources of finance, usually under 24 months, and uses regular small payments, typically paid every business day.
7. Commercial mortgage
If you’re looking to grow your business, you might be looking to invest in property. Commercial mortgages enable you to secure a 70-75% mortgage lasting up to 25 years. For investments, the amount you can borrow depends on the rental income generated by the property, up to 65% of the purchase price.
Lenders consider commercial mortgages higher-risk than regular home mortgages. The interest rate is therefore considerably higher, and aren’t fixed-rate for extended periods. That said, commercial mortgages offer better interest rates than business loans. The interest on your mortgage is tax-deductible, and you can rent out the property to generate extra income to match increased interest rates.
Be aware that mortgages are a form of secured loan, meaning the property serves as collateral for the lender. If you default on your payments, you’ll lose ownership. Some lenders require additional security in the form of other fixed assets. It’s worth using a mortgage broker to help you find the best offer, as they’ll advise you on which providers to apply to, and can help you find the highest loan to value ratio (LTV).
8. Asset finance
Asset finance is a form of financing for businesses which require capital to purchase high-value equipment or machinery, or for companies who need to release cash from assets they already own.
Asset finance for new assets comes in the form of hire purchase, a finance lease and an operating lease. Alternatively, you can use asset finance to secure lending against an existing asset, if you can’t keep up with the loan payments, known as asset-backed lending.
Asset finance differs from more traditional asset-based or secured loans, in that the asset acquired by the financier is typically the security used against the loan, meaning the business does not need to provide another form of security. You can find the main types of asset finance explored below.
Hire purchase (HP) is a form of asset finance where firms can acquire assets through an asset finance provider, who agrees to purchase an asset that the business needs, outright. The company then spreads the cost out over time in instalments paid to the asset finance company. Ownership is transferred to the business at the end of the leasing period, once all instalments have been paid.
Hire purchase is an excellent option if you don’t have the current capital to make the purchase. It’s a fixed-rate loan with low-interest rates, ideal for assets that you need long-term. You can pay a large initial payment followed by smaller amounts, making it one of the more flexible asset finance options. The payment term is usually 1-5 years, so if you only need the asset in the short-term, you should consider a less risky option, such as leasing.
At the end of the leasing period, you’ll need to pay a final fee, which is a percentage of the asset’s value. In accountancy terms, the asset is treated as if you own it during the lease period, meaning it will appear as an asset on your balance sheet. The hire purchase amount shows as a liability on the balance sheet, which reduces as the firm makes each HP payment. You therefore need to consider whether the asset will depreciate over time, as while your asset will have less value each year due to depreciation, your liability remains the same.
A significant disadvantage of asset finance is that you don’t officially own the asset until the end of the lease-period, meaning you’re unable to make any modifications to the purchase until this time has elapsed. If you need autonomy over the asset, consider other forms of finance.
9. Finance Lease
With a finance lease, the asset finance provider agrees to purchase an asset outright and lease it to the business over a fixed period. It works in a similar way to hire purchase, the key difference being that the company will never own the asset: the intention is always that the finance company will sell the asset at the end of the lease period. In some cases, the finance company may offer the business a share in the sale value of an item when they sell it.
A lease is useful for bigger assets such as land or property that you’ll use over longer periods. As you don’t technically own the asset, it doesn’t appear on your balance sheet, which can offer some tax benefits. You can offset your rental costs as an expense against your profit, allowing you to claim VAT. However, you will have to pay for the full value over time, making it only suitable for lease over most of the asset’s life.
Operating leases are a preferable option to lease equipment, as the lease company takes care of the maintenance. The rental agreement also includes a set term, which is useful when a business may not need an asset for its full usable life. You only pay for the value of the asset over the time of your rental agreement, which is usually cheaper than paying for the full value of the item, as with a finance lease.
As with a finance lease, the asset won’t appear on your balance sheet, meaning you can offset your rent against your profit. At the end of the term, the business can either choose to renew the lease or return the asset. During the lease period, a company has full access to the asset, meaning you’re responsible for insurance and maintenance costs.
Asset-based lending allows businesses to release cash from existing assets. The company sells an asset to a finance provider for an agreed amount and then pays back this lump sum in the form of a lease, making regular payments over an agreed period. The company recoups the purchase cost and interest. This form of asset finance is useful if a company cannot keep up with maintenance costs or loan payments on a valuable asset.
Crowdfunding has really grown as a source of investment for businesses overall and for specific products. It involves taking a small amount of investment from a lot of people to equal a much larger sum. Crowdfunding can be divided into two types:
- Equity based: You give away equity in return for investment funds.
- Rewards based: You give away perks, rewards or thanks for people supporting a specific product or business.
- Loan based: You can crowdfund loan, hence source of finance.
High tech and product based businesses generally use crowdfunding. It’s important to consider that the success of a crowdfunding campaign is typically reliant on your ability to market your proposition. It can be a great source of finance, especially if you’re launching a product, as you’re effectively doing pre-sales to fund development and launch. There is also a good range of crowdfunding platforms to choose from, including kickstarter, Seedrs, Crowdcube and IndieGoGo.
If you’re looking to raise money to start or grow your business, equity-based crowdfunding has become a popular way to do it. Be careful though; unless there’s a nominee structure, you may have to report to thousands of small shareholders if you raise funds this way.
Small business grants are typically awarded by the government, a government body or a charitable outside body. Grants usually take the form of finance, available to organisations or individuals that meet specific criteria and undergo an application and vetting process.
For example, Innovate UK is a government body providing grants for innovation in certain areas of the UK economy. These grants aim to help support specific businesses and sectors of the economy engaged in a particular type of research and development.
Grants can range in size from £500 to over £1 million, with the majority in the UK sitting between £3,000 and £100,000. Grants are a brilliant source of finance for businesses as they don’t have to be paid back. Still, they are tough to apply for, very competitive and often only available for very specific companies or those engaged in particular areas of research.
The main consideration as to whether you apply for a grant or not should be the time it will take you to complete the application, compared to the likelihood of getting the funding, with further consideration given to what you could be doing instead of applying to raise finance.
12. Venture capital
Venture capital is a good option for high growth companies looking for serious finance in exchange for equity. Typically, VC money in the UK starts from £500K and goes up to £50 million for a single investment.
VC is a popular way for companies who are in a growth stage to raise; you’ll need a business that is scalable and has evident traction to date. Also, be prepared to be seriously audited if a VC is looking to invest in you: have your books and plans up to date.
Finally, bear in mind that you’re taking on a serious equity partner who has experience investing professionally. VCs bring lots of money but also pressure and structure beyond what you have currently, so make sure you’re ready for that.
13. Angel investment
If you’re looking to raise a small amount of finance to start out, then raising investment from angels is probably the best way to get it. Investments typically range from £10K to £500K (under SEIS or EIS). Raising from an angel is often much more straightforward than raising from VC or institutional funds.
With an angel investor, you’ll also likely get a mentor and an experienced partner as an investor to support you in starting your business. Try to make sure your partner understands your area as well; experience can be more valuable than money. A media company, for example, should get an investor who has significant experience in media.
Although the due diligence is much less than with VC investment, you’ll need to make sure your paperwork and finances are up to date and ready for inspection. Often the only way to find an angel investor is through your network, so go out to events and start mixing.