There are lots of options open for businesses trying to raise funding and it would be impossible to cover them all here. That doesn’t necessarily mean that raising funding can’t be challenging, particularly if a business is new and cannot produce a trading history. Appropriate funding streams are determined by a number of factors, such as:
- The maturity of the business; whether it is a new, growing or or an established concern;
- The sector the business operates in;
- Whether the business has assets that can be secured against any borrowing;
- The expectations of potential investors; and
- To what extent the business owners want to retain full control.
Bootstrapping and friends and family
Bootstrapping is when people finance a new business using capital and credit available to them in the form of savings, overdrafts and credit cards. Obviously this is risky because if the business fails, the debt will still be owed. Borrowing from friends and family is equally risky, although this time the risk lies with them. They have no real evidence that you can make a success of your enterprise, and lend the money as an act of faith in the entrepreneur. They should only do this on the understanding that they might lose their investment.
Crowdfunding is where a small group of investors decide to take a risk and back the business. It is useful in situations where the business has no access to capital and is unable to borrow. With crowdfunding each investor provides an unconditional grant.
Bank loans and overdrafts
Whilst it is always possible to apply for a business loan, and banks often look favourably on applications, bank loans represent an inflexible form of business finance with rigid repayments set over a specified period; lenders will require information about the business and possibly security against the loan. Overdrafts attract a higher rate of interest than loans, can be cancelled by the bank at short notice and, except in the case of large businesses with, at least, hundreds of thousands of pounds in annual turnover, are unlikely to be large enough to provide the level of funding required. Banks are likely to look more favourably on businesses that already hold accounts and do business with them.
If a business is looking to expand in new markets it may be able to attract venture capital. Venture capitalists are shrewd investors who will examine the business in some detail before advancing funding. Their ultimate aim will be to make their investment work to increase the overall value of the business so that it can be sold at significant profits for both themselves and the business owner.
Invoice financing is a good way for a business to ease its cash flow problems and free up its working capital. Invoice financing work on the principle of a lender advancing finance on the basis of outstanding invoices as soon as they are raised; the business clears the borrowing once the customer pays the invoice. There are several methods of invoice financing.
With invoice factoring a business loses some control because it hands over its sales ledger to the factoring company who obtains payment from the customer and, in addition, undertakes credit checks and other credit control functions. As customers of the business will know it is using a factoring company, it needs to work with one that doesn’t alienate customers who, as a consequence, might decide not to trade with that business in future. For new businesses in particular, using a factoring company frees up time the business can spend promoting trade and building relationships with its customers.
Invoice discounting works in a similar way to factoring, except the business retains control of its invoices, credit checks and credit control functions. The lender advances a percentage of the value of each invoice which the business repays when the customer settles it. Unlike invoice factoring, invoice discounting is not evident to customers. However, to be able to secure an invoice discounting facility a business has to be quite mature with a significant annual turnover.
Businesses can raise funds through asset financing by using its existing assets as security against which to raise capital for development, or it can take out finance to buy new ones.
Asset backed lending
Asset based lending is very straightforward and money obtained and secured on the basis of a valuable asset is often termed refinancing. If the business fails to make repayments the lender may take possession of the asset. Whilst there are a number of asset based lending schemes on the market, all with slightly different conditions, two basic conditions are:
- The asset must be crucial to the business; and
- The asset must be transportable so that if the need arises it can be removed by the lender.
Funding new assets and equipment
In order to avoid any capital outlay which could deplete it's working capital or affect cash flow, a business might choose to borrow to buy new assets.
With equipment leasing, the lender buys the asset and leases it to the business. The only initial outlay for the business is the first monthly instalment. At the end of the agreed lease period the business has the opportunity to buy the asset and payments made to date are reflected in the selling price. Other alternatives include renewing the lease or taking out a new lease on a more up-to-date version of the asset.
Business hire purchase agreements work in a similar way to domestic hire purchase. Unlike leasing the business owns the asset. There is no initial outlay other than a deposit and monthly instalments. There are some important considerations that a business needs to make before taking out hire purchase, including:
- In order to make the hire purchase worthwhile, the asset needs to be integral to the business. If it will only be required for a limited time leasing might prove a better option;
- How much the asset will depreciate over the hire purchase period. Although, if the asset is an integral component of the business and has a long life, depreciation is unlikely to be important; and
- Consider how frequently the manufacturer of the asset releases a new version. Having the latest model of a haulage wagon may not be that important, whilst having the latest packing machine that does so much more than the previous version could be very important.
Businesses operating in property development or investment have a variety of options by which to raise capital.
A commercial mortgage is used to buy any premises not classed as residential. Commercial mortgages operate like domestic mortgages and are usual taken out to buy premises at business start-up, or buy premises that were previously rented.
Property can often be bought at auction fairly cheaply. However, the winning bidder has to be able to settle the bid, usually within 28 days. Some lenders specialise in this type of funding and will provide a guarantee prior to the auction taking place. Even less established property buyers may be able to secure auction finance once a bid is won and the deposit (usually 10%) has been paid.
Bridging loans are usually taken out to finance property development, with the nature of the agreement determined by the scale of the project. For example, a bridging loan might be taken out quickly to finance essential refurbishment work that could leave the business in a more profitable position after 3-12 months, by which time a mortgage will have been obtained to clear the bridging loan. Bridging finance
is expensive and should only ever provide a short-term solution to borrowing requirements until a longer term solution can be found.
Stock finance works in a similar way to asset finance in that borrowing is secured on stock, rather than other tangible assets. Lenders operating in this market will want to examine and monitor who the business buys from and sells to, and also the volume of trade.
Merchant Credit advances
Merchant credit advances are suitable for retail businesses where income comes mainly from card payments by customers. The lender will determine the monthly average of payments taken in this way by the business and agree to lend a certain amount based on that. Repayment terms are flexible and are usually based on a percentage of the monthly takings. This means that a business pays more in months where it's income is greatest, and pays less when there has been a downturn in sales. What is more, the lender deals directly with the company that process the card transactions, deducting the loan repayments at source.
Advantages of merchant credit
- The money never comes into the business bank account, so business owners don’t have to worry about making the repayment. This frees-up time the business can spend on other activities;
- Repayment terms are set at a level that corresponds to the volume of business done; and
- Credit options for the remainder of your business remain open.
Disadvantages of merchant credit
Although merchant credit can be an excellent way for a retail business to raise capital it does have some disadvantages, including:
- The amount that can be lent is directly related to sales, so this may not be enough to finance the purchase of a large asset, expansion, or company redevelopment;
- If the business takes in money through a variety of sources, such as card, cash and bank transfer, the monthly amount of card payments may to be insufficient to to make merchant credit a workable option;
- Choice of lender might be limited to the companies your card processor deals with.
Pension led funding
It is possible for a business to raise funds from the pension pot of a director, providing:
- The pension pot has a value of at least ₤50,000;
- The director knows and is in agreement; and
- The pension provider agrees.
This type of lending can be tailored to suit the Director's and
A final word
The sources of lending covered above are by no means exhaustive. Peer-to-Peer lending is becoming very popular and there is a range of Government grants available to businesses who meet the criteria. Equity investment can also be a good way for a limited company to raise money, providing it is happy to take additional investors on board who may want a say in future business decisions. Some of the financing methods mentioned above can be extremely complex and so the advice to any business considering taking on any form of borrowing is to take independent financial and legal advice. To take on borrowing, without fully understanding what the liabilities and responsibilities are, put both the business, and possibly personal assets at risk.