Whether you’re looking to start or grow your business, you’re going to need some form of funding to get underway. However, figuring out what sources of funding are available to you as a business owner is trickier than you might first think.
Overall, there are two primary forms of financing available to small businesses: debt and equity. These are both covered here, as well as further types of funding. This guide will help you navigate these different sources of funding, discussing the advantages and disadvantages of each funding option, including the stage of business they suit best.
1. Small business loans
Traditional business loans, provided you can get them at a reasonable rate, are still an excellent way to raise finance for your venture, particularly if you are already generating revenue. Remember that any loan is debt finance which you are obliged to pay back. Carefully review any terms you agree to and, when possible, try to find other forms of finance before you consider taking on any debt.
The Startup Loans Scheme is a government stimulus package that gives you access to a low-cost loan. The scheme is an excellent way to fund a new venture or expand an existing small business. The loan also comes with 12-months free mentoring, which is invaluable for new entrepreneurs.
Typically up to £10,000 is available for those starting out and for those looking to expand, this amount goes up to £25,000. The terms are also usually very favourable compared to traditional lenders but be aware that a startup loan is personally owed by the entrepreneur who takes it out, not the company. Many entrepreneurs overlook this aspect, so be sure to read the paperwork thoroughly.
2. Small business grants (Government and private)
The UK government, local authorities and private organisations provide funding and grant opportunities to small businesses across the country. These grants are typically available for new companies or existing businesses who are supporting economic growth in a particular area or nationwide, by developing technology in a specific field or helping the disadvantaged.
To be eligible for a small business grant, you must meet the grant-specific criteria. You’ll then need to apply and undergo a vetting process. The main benefit of grant funding is that it’s effectively free money, which you don’t have to pay back.
However, sometimes grants are not the right funding route for your business. Some have very specific eligibility requirements, and some use a very time-consuming application process. Consider whether you can afford to wast the time it takes to apply for a grant, should you be unsuccessful.
3. Business accelerators
A business accelerator is a programme offering developing startups a small investment in exchange for equity, along with mentorship, office space and network access that will enable them to become sustainable and self-sufficient in the long-term. This initiative also provides access to future investors once entrepreneurs have completed the accelerator programme.
Business accelerators can be a great way to grow your startup business. Do note, however, that the failure rate beyond the accelerator programme is exceptionally high; many companies face difficulty transitioning from the high level of support they receive in the programme to complete autonomy.
4. Business overdrafts
Business overdrafts are effectively a super-fast way to set up a loan. When your balance hits zero, you can carry on making payments up to the limit set with your bank, known as the facility.
Having an overdraft facility is a useful option if your business operations include seasonal activities, where you may have short-term cash flow shortages. If your business needs a constant loan function to trade, then these are likely the best solution for you.
Be aware that this type of finance usually comes with higher interest rates than conventional loans. What’s more, many banks charge an overdraft fee on top of interest. The bank may also demand that you pay back the full amount owed at any point, meaning this finance option carries significant risk.
Crowdfunding platforms allow you to raise funds from a number of small contributions from many individual investors or purchasers. You can either run an equity-based crowdfunding campaign, where you exchange equity for investment, or a reward-based crowdfunding campaign, where your investors receive perks or rewards in exchange for their capital.
Useful platforms for crowdfunding a project include kickstarter, Seedrs, Crowdcube and IndieGoGo. Crowdfunding doubles as effective marketing, as you’re effectively driving pre-sales to fund your project.
Keep in mind that it usually takes a significant amount of preparation and marketing to create and run a successful crowdfunding campaign. With that in mind, it is an excellent form of alternative finance for small businesses.
6. Business credit cards
Business credits cards can be a handy source of finance for trading entrepreneurs. Credit card limits can reach £10,000, which is effectively free money provided you pay off the debt within the interest-free period.
If possible, you should avoid using business credit cards to start a business. The interest rates are high with strict repayment periods; APR can exceed 20%, and the interest-free period is typically 30-45 days. If you fail to pay, it is all too easy to get into crippling debt. This can also have a damaging, lasting effect on your company’s credit rating.
That said, if you are a trading business and you need such a facility, it can be a useful alternative to an overdraft as you can pay it off monthly. For temporary, short-term use, it’s a fantastic way to boost your instant purchasing power.
7. Business angels
Business angels are private investors, typically former entrepreneurs or wealthy individuals, who invest in startups and small companies in return for an equity stake of usually 10-20%. Business angels are a fantastic way to secure seed money for a project, as they can offer advice, guidance and mentorship through a project.
This type of funding usually ranges from £5,000 to £150,000; the higher end often comes under SEIS. When taking on an investor, make sure you’re confident that you can establish a good working relationship with them, as you’re going to be in business together for a while. Their stake in the project also dictates an amount of control that they’ll have in the company.
Business angels are advantageous as they are usually willing to take far bigger risks than banks. There’s also no obligation to pay back the invested capital if the venture flops.
8. Invoice finance
If your business is trading and generating revenue, then invoice finance is a great way to improve your cash flow and raise funding quickly, especially for service companies with long invoice payment terms of 30, 60 or 90 days. Invoice finance means that a third party will buy unpaid invoices owed to your company. They’ll pay you up to 85% of the value immediately and the remainder once the invoice has been paid to them, minus a fee.
Invoice finance is a fantastic way to cover gaps in cash flow, where clients frequently pay late or have extended payment terms. On top of this, many arrangements protect the company from incurring debt if customers don’t pay their invoices.
To secure invoice finance, you’ll need evidence that you generate significant revenue and that customers are usually consistent in paying their invoices. Financiers will want to see detailed accounts before they buy your invoice as debt, so make sure that your finances are in order. It’s also important to note there are two different forms of this type of finance, being invoice discounting and factoring.
9. Venture capital
Venture capitalists invest huge sums into startups or expanding businesses with tremendous growth potential and traction, typically investing considerably more capital than angel investors. VCs are professional investors, responsible for investing and growing some of the world’s most innovative companies, including Facebook, Spotify and Airbnb.
As with angel investors, there’s no obligation to pay back the investment if your startup fails. Venture capitalists are attractive as they can offer considerable business knowledge, vast sums of capital and often take much higher risks.
With higher risk comes the expectation of a higher reward. VCs will expect considerable returns and will want a clear exit plan, in the form of acquisition or selling shares. These are professional investors, so they’ll want to see a solid business plan and sound accounts.
The type of funding is typically reserved for more developed technology businesses. It’s often more complicated, as such significant sums of money come with more hands-on investors who will want more control over their investment, and therefore within your business.
10. Asset-based lending
Asset-based lending is a form of asset finance that allows a business to release cash from its existing assets. If you’re struggling to meet loan payments on a particular asset that you already own, you can sell this asset to an asset finance company for a lump sum. You’ll then lease the asset from the provider over an agreed period.
If your business has a range of assets, such as property or vehicles, you can use these items as security, or collateral, to secure a reasonably significant business loan, depending on the value of your assets. This method is known as asset refinancing. Similar to a mortgage, businesses typically undertake asset-based loans by putting up physical assets as security to gain access to a loan from an asset finance company.
Hire purchase is another form of asset finance, where companies can spread the cost of a particular asset over an extended period. An asset finance provider agrees to buy the asset for the company outright in return for a deposit, usually 10% of the purchase value. The company must then repay the remaining asset value in regular instalments, with a final payment at the end of the lease period. Following this final payment, the company receives ownership of the asset.
HP is a useful form of funding for companies that don’t have sufficient capital for items that they need. You’ll need to pay for the full value of the asset at its purchase date over time, even if it depreciates in value. Hire purchase assets will appear as an asset on your balance sheet during the lease period and the hire purchase amount will appear as a liability, less any HP payments you’ve already made. For this reason, it’s worth considering whether you need the asset in the long-term: if not, it may be more cost-efficient to use a lease.
Repayment options are usually flexible in terms of amount and frequency when using hire purchase. The payment term is generally between 1 and 5 years long.
A finance lease is a favourable option for companies that don’t have the capital to purchase necessary assets, where companies only have use of the assets for a limited period. As with hire purchase, a finance provider agrees to purchase an asset. However, instead of paying an upfront fee and paying back the full value of the asset, the company leases the asset over a set period, covering only the value of the asset within that period.
The main difference with hire purchase is that the business will never own the asset. In the case of a finance lease, the asset finance provider intends to sell the asset at the end of the lease period. In some cases, the finance company may offer the business a portion of the sale value of the asset.
A lease is suitable for more substantial assets that your company needs for a limited term. As you don’t technically own the asset, you don’t need to list it on your balance sheet. This means you can offset your rental costs for property or land against your profit, which can be a significant tax benefit.
11. Business competitions
There are a considerable number of business competitions open to SMEs in the UK. Winners can receive ample funding as well as business guidance and support, mentorship and press. The competitions usually offer prizes in the form of a lump finance sum of up to £1 million, depending on the backing organisation.
These competitions typically target startups and early-stage businesses in a particular field. Some are only available to companies in a specific industry or projects with specific aims.
12. Commercial mortgages
If you’re seeking funding for property investment, consider taking out a commercial mortgage. You can borrow up to 75% of the property value, or up to 65% if you’re generating rental income from the property.
Commercial mortgages come with higher interest rates than personal mortgages. They’re considered high-risk: for this reason, a commercial mortgage is a form of secured loan, where the property is collateral. If you’re no longer able to pay your mortgage, you’ll lose ownership of the property to the lender.
Commercial mortgages are more attractive than business loans as they offer lower interest rates, which are tax-deductible. You’re also able to rent out the property to cover the mortgage payments. If your interest rates increase, you can reflect this increase in the rent you charge on the property, too.
Taking out a commercial mortgage can be extremely complicated. Many mortgages require you to put up extra security in the way of other fixed assets. A mortgage broker can help you find a mortgage suitable for your business with the best loan to value ratio (LTV) and ensure that you fully understand all the payment terms.
13. Merchant cash advance
A merchant cash advance is a form of finance where companies can receive funding in exchange for a percentage of their daily credit card income. It’s only available to companies who take the majority of their sales using a card terminal, as the advance amounts are based on card sales. An MCA provider will operate through your card terminal provider and offer you a lump sum advance based on your average monthly sales taken by card.
An MCA is a smart option for seasonal businesses, as they can repay their loan in proportion to the revenue coming in, offering a safety net for companies with fluctuating cash flow. Most providers only consider companies that take an average of £3,500 in card sales per month and have been operating for a minimum of 6 months. The lender will take payment every business day until the loan is paid off.
14. Tax reliefs
An indirect source of business funding comes in the way of tax relief. Reducing your tax bill opens up funds that you can use elsewhere in your business. Tax relief options available to SMEs include the Employment Allowance, which allows eligible employers to reduce their National Insurance liability up to a certain threshold, and the Annual Investment Allowance (AIA), which lets you deduct the value of eligible items off your profits before tax.
Specific tax relief schemes can also help you to secure investment by drawing individual investors to your business. The Seed Enterprise Investment Scheme (SEIS), for example, offers significant tax breaks to investors buying shares in your company. You can typically secure up to £150,000 in funding through SEIS.
On top of these, there are hundreds of privately and publicly funded grant schemes which offer a reduction in tax or cash rewards. Take a look at our list of grants available to small businesses for more information.