One of the biggest challenges for small businesses is to source suitable finance. Whether cash is required for start-up costs (for example vital equipment, premises rental or to order materials), or to finance expansion, resolve short-term cash flow difficulties or pay staff wages, finding money when there’s a mismatch between income and outgoings is tough. Unfortunately, many smaller enterprises end up in a Catch-22 situation: they need an injection of cash in order to improve their profitability, but haven’t got the cash because their business isn’t generating sufficient income. Fortunately, if you’re in this difficult position, there are numerous options out there to raise the funds you need. We’ve brought together a range of ways to finance a small business, hopefully giving you the information to get the cash you need.
- Borrow from friends
- Angel investors
- Private equity – is this the best way to finance a small business?
- Finding a partner – not a sugar daddy/mommy but a business partner
- Finance my small business with crowd funding
- How do I finance my small business? Bank loans could be the solution
- Credit cards
- Business overdrafts
- Government grants
- Selling equity/shares in your company
- Invoice financing
- Re-mortgaging property
- Keeping a Job
- Working on the side/side hustle
- Sell assets
- Credit unions
- Alternative finance
- Trade credit
Borrow from friends
If you believe in your venture and have thought through the finance needed to improve your profits, borrowing from friends could work really well. If you have a number of friends, the total amount needed could be split between them, making raising the capital easier. Friends will often lend when a bank or other lending institution won’t consider your application, making them a good source of funds for new businesses or those with a less-than-ideal credit history. The main downside to borrowing from friends is that if you can’t afford to repay the money, you stand to lose mates as well as potentially losing your business. For this reason, it’s important to be as sure as possible that you will be able to stick to the repayment arrangements you agree, before accepting the loan.
Many families are only too happy to provide funds to enable a small business to flourish. The obvious advantages of borrowing from family are: flexible repayment periods; little or no interest; no need to pass credit checks; the potential to borrow sizeable sums; and the chance to grow a business that will potentially benefit the family directly in future years. Potential problems usually occur when the business doesn’t make enough money to allow repayment to take place. Particularly if there isn’t any form of written agreement in place, there is the risk that family relationships can begin to break down over the non-repayment of the debt. The personal nature of the borrowing means that it’s usually only best to borrow from family if you are as sure as you can be that it will be repaid.
Anyone that sinks their savings into their business already has a strong motivation to turn a tidy profit! Many people find that using their own savings gives them added enthusiasm and drive to make their business successful: after all, nobody wants to lose their own money on an unsuccessful venture! In a similar way to borrowing from friends or family, using your savings means there’s no need to pass a credit check or convince an outside agency that their money is safe with you. It’s worth remembering, though, that sometimes a business can fail due to forces which are beyond the owner’s control. In such circumstances, losing your life’s savings because they’ve been sunk into the business can be a real possibility. You may also face personal problems paying the bills if you have no savings to fall back on and your business is failing.
Particularly if formal borrowing avenues are closed to you, an angel investor can be a good option. Angel investors are typically entrepreneurs who agree to purchase a stake in your business. You can use the money they provide to grow your enterprise, in return for selling a percentage of the shares to your angel investor. Typically an angel investor will want to own somewhere between 25 and 40% of your shares, depending on how risky they feel the business may be. Although some people aren’t comfortable with someone else owning part of their business, it should be remembered that investors potentially stand to lose all their money should the venture fail, which is why they may well ask to own a sizeable percentage. Angel investors are frequently experienced, successful business people who can provide added expertise and input to help your business succeed.
Private equity – is this the best way to finance a small business?
A private equity fund is usually money which has been invested by a range of companies and individuals. The private equity company then invests it in a business, with a long-term view of generating a profit, so that the companies and individuals who have invested in the equity company receive a profit. Although many private equity funds invest in larger companies, there are still a few who will consider a smaller enterprise. The main advantage of private equity funding is that it can often be used flexibly and over the longer term. Businesses also benefit from the expertise which the private equity firm has to offer. The main downside is that the equity firm will want to have a major say in how your business is run, which some owners find difficult to deal with.
Finding a partner – not a sugar daddy/mommy but a business partner
One of the answers to the eternal question of how to finance your small business could be to find a partner. A business partner is basically an individual or company that agrees to provide resources in return for a share of your profit. The exact arrangements can be highly variable and change over time. Business partnerships may grow organically, or be established initially. The adaptable nature of a partnership can mean it works effectively for businesses of all shapes and sizes. Unfortunately, just like any other partnership, there is the potential for a business partnership to go wrong. For this reason, we recommend that some sort of written agreement is put in place to ensure that the arrangement can be ended as cleanly and fairly as possible if necessary.
Finance my small business with crowd funding
If you’ve got a business idea that you think is a winner, testing its validity by floating it onto a crowdfunding platform can work really well. Not only is it possible to generate large amounts of money quickly, but your pitch is centralised, so there’s no need to make multiple applications to funders. Generally you will provide people with the products of your labour: essentially crowdfunders are paying in advance for your goods or services. This gives you free money without the need for others to be paid part of your profits or to be involved in your decision-making. Crowdfunding does require a fair amount of self-publicity in order to attract funders. If you haven’t patented your idea, someone may see it on a crowdfunding platform and steal it. It’s also often the case that if you don’t meet your crowdfunding target, the sum raised is returned to the crowd funders and you have gained nothing from the endeavour.
How do I finance my small business? Bank loans could be the solution
A traditional, dependable and reputable form of finance, the main barriers for small businesses when it comes to accessing a bank loan are a lack of trading or credit history, or insufficient income to service the loan. Banks are traditionally risk averse, preferring borrowers who can demonstrate their credit behaviour over a few years and have enough income to repay the loan instalments on time. Generally bank loans are quite inflexible products: repayments must be made on time; there is no reduction in interest for an early repayment; default can lead to a poor credit record, jeopardising the chances of future loans.
As a short-term form of borrowing, credit cards can work. Particularly if you intend to clear the credit card in full each month, the borrowing will be interest free. Credit card money can also be used on a wide variety of goods and services. There are two issues with using credit cards: the first involves obtaining a card in the first place. If your business is new or has a poor credit rating, you may not be eligible for a card; secondly, interest charges can be significant. If you don’t repay in full each month, credit cards are a very expensive way to borrow. Failure to meet the minimum repayments on time can lead to further financial penalties, compounding a tricky financial position. Generally, unless you are extremely confident you can repay in full and on time, credit cards are not an ideal form of business finance.
If you require finance on an “as and when” basis, an overdraft could be right for you. One of the main benefits of an overdraft is that once it’s in place, you usually only pay interest if you use it. An overdraft can work well when it comes to managing cash flow, or when you have an unexpected expense. Because banks charge interest when you use an overdraft facility, if you suspect that you will usually be “in the red”, it may be more cost-effective to look at a form of borrowing with a lower (or non-existent) interest rate.
Successive governments have recognised the benefits which small businesses bring to the economy, as well as the barriers which they face in obtaining adequate finance, particularly during the start-up and early days. For this reason, there are a number of grants available, depending on the nature of your business and your own personal circumstances. Grants are normally interest free and do not require repayment. For this reason they can be a risk-free source of funding. The main challenges when it comes to accessing a grant is meeting the relevant eligibility criteria, spending the cash in line with the criteria and delivering the agreed outcomes. Because the grants come from the public purse, there is frequently a considerable amount of paperwork to fill in and the criteria for acceptance can be quite narrow.
Selling equity/shares in your company
A traditional method of raising necessary finance, selling corporate shares is a way of sharing the risk of your business venture. Investors will buy one or more shares, giving them an interest in your business. Once investment has taken place, your shareholders will expect to see a return on their investment, as well as regular reporting on business progress to date. Selling shares means that you’re not actually taking on additional debt, or paying interest. The major downside of parting with shares is that you lose a degree of control over your business, particularly if one or two investors buy a significant number of shares.
When considering how to get finance for small business use, invoice financing is a common option. This process involves using an invoice financing company. They “buy” one or more invoices, paying a percentage of the invoice value up-front, followed by the balance (minus their commission), once the invoice has been paid. Once the invoice is sold, the invoice financing company assumes responsibility for its collection, which can reduce workload, particularly when you have a reluctant payer! The cost of commission needs to be weighed against the costs of other forms of finance. In addition, if you’re a new business or are set up so that invoices form only a small part of your operation, this form of finance may not be right for you.
When considering how to finance a small business, remortgaging your existing property is an option. If you have equity in your property, it’s possible to borrow against this, increasing your debt to the mortgage lender. It’s important to remember that your property may be at risk of repossession if you don’t keep up the payments. It’s also worth looking at the rate of interest offered and the eligibility criteria for remortgaging: different providers are prepared to accept varying levels of risk.
Keeping a Job
Most businesses make very little money in their early days, which is why many people prefer to keep their main job going at the same time as their business is launching, in order to minimise the risk of a reduction in income. Whether this is a good option or not depends on personal circumstances, the potential difference in income and how motivated you are to pursue the business when you already have an income stream. Obviously a job means less time can be spent on the business; equally, not working means it’s possible to devote more time to the business, hopefully resulting in a faster generation of profit.
Working on the side/side hustle
Taking on part-time work or competing in the gig economy can be a good method of boosting personal finances. The main disadvantages of a sideline are:
– Sidelines can often be very badly paid in comparison with your business.
– “On the side” earnings may be taxed in a completely different way to the business. This means that you will have to be careful to separate your additional earnings from profit your business makes.
– Time spent on a side hustle is time that could be spent increasing the profitability of your business.
– A lack of focus on your business can mean it isn’t given the attention needed to help it succeed.
“Sell stuff” is often touted as a way to answer the question of, “How do I finance my small business?” If you have business assets which are no longer needed, it makes sense to sell them. Similarly, start-up business owners may well sell some of their own personal possessions to provide the capital needed to commence their business venture. As long as you get a good price for your assets and they’re not items which the business is likely to require in the future, selling unnecessary assets can be an interest-free, low-risk finance generator.
How to start a small finance business is a common question: credit unions are one of the answers. Usually, credit unions lend small amounts of money for competitive rates of interest. They are set up to provide loans to people or businesses with either a limited or poor credit history, meaning they are often a good alternative when a bank or building society isn’t an option. Credit unions are regulated and can often provide additional business advice and financial education, which can be a valuable resource for some business owners. Some credit unions also require that you save with them for a period of time before you borrow. Generally, if you need a small, low-cost loan, a credit union is an excellent option.
“Alternative finance” is an umbrella term for a wide variety of commercial brokers, lenders, loan firms and similar enterprises. A viable alternative to banks and building societies, the main benefit of accessing alternative finance is that lenders are prepared to tolerate a higher level of risk than the conventional banking sector. This is particularly useful for smaller businesses or for new businesses, many of whom will be automatically rejected by a bank. The main downsides of alternative finance can be high interest rates and fewer safeguards for you and your business should you be unable to meet the required repayments. Provided you pick with care, however, it’s possible to end up with a product that’s tailored to your needs, sometimes for a surprisingly competitive price.
A form of “finance +”, accelerators don’t just give you access to ready cash! An accelerator can also give start-up and small businesses access to legal support, financial education, networking opportunities and publicity, as well as specialist business support. In return for all this, businesses hand over a percentage of their equity: the exact amount varies depending on the accelerator programme offered. The aim of most accelerators is to quickly enable the growth of a company, giving it the tools and resources needed to thrive. Each accelerator programme has its own set of eligibility criteria. Some of the most popular are listed below:
A time-honoured method of growing a business, bootstrapping is a method of financing which doesn’t rely on credit. Start-up costs are met from personal savings or assets, or borrowed from friends and family. Once operational, business growth is financed through the profits raised by customer transactions. This model can mean that businesses grow more slowly and may also result in time-critical opportunities being missed. That said, the lack of debt that needs servicing, as well as the fact that owners retain their autonomy, mean that this is still a popular funding route.
If you are confident in the success of your venture, but need capital for materials and on-going operating costs, presales could work for you. Presales involve customers paying in advance for their goods, receiving them once sufficient cash has been raised to fund their production. Obviously not all products and services are suitable for presales. Businesses using this approach also need to be as confident as they can be that they can deliver on the orders: few things wreck a business’ reputation faster than not delivering to the customer! Presales are a cost-effective method of getting money up-front, although the amount can be variable and a critical mass is sometimes needed before operation to fulfil the orders is viable.
Ideal if you need materials but can’t afford to pay for them up-front, trade credit is effectively a loan of products from another company. What it means in practice is that your business can order materials or similar, then pay for them later. Trade credit is usually extended for a few weeks or months: 30 days, 60 days or 90 day periods are common. Sometimes creditors will provide incentive discounts to pay early. Trade credit is a way of ensuring customer loyalty, at the same time as providing small businesses with a helpful resource when they have a temporary cash flow problem.
Although it’s never easy to find appropriate funding for a small business, hopefully some of the suggestions given above will provide a suitable way forward. No matter what type of funding you opt for, it’s important to ensure that you only borrow what you need and are as confident as you can be that you will be able to repay the money. Although borrowing needs to be approached with caution, in many circumstances a timely injection of cash is all that’s needed to enable your business to progress upwards to the next level. Get in touch to find out more about securing flexible, low-cost finance for your new and /or small business.
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