Small businesses routinely face all sorts of hurdles just trying to keep things running along profitably. Among those hurdles is the challenge of financing. Whether the need is for start-up funding, investing in new equipment or inventory, or meeting expansion goals, getting the funds needed can be a challenge.
The good news is that there are a fair number of options available to UK small business owners. Borrowers can choose one financing option or combine several together for a complete package. The key is creativity mixed with reasonable caution. When financing options are used correctly, they can make the difference between success and failure.
Different Types of Financing
There are seven fundamental types of financing available to UK businesses. For a basic overview of how each one works the GOV.uk website is a good place to start. Their guide to business financing breaks down six of the seven options and explains them in language that is easy to understand.
Throughout remainder of this article, we will discuss each of the seven options in detail. But for introductory purposes, those options are:
- traditional business loans
- business angels
- investment financing
- invoice financing
- overdraft service
- asset lease financing
What options are right for any given business depends on a number of factors. For example, long-term financing needs are managed better by traditional loans, business angels, and asset leasing. Short-term financing needs might be better met through grants and invoice financing.
Employing the services of a business adviser might be a good idea if an owner is having trouble plotting a financial course. Business advisers have the expertise and knowledge to help navigate the plethora of financing options. With that said, we will move on to discussing each option listed above.
Traditional Business Loans
Traditional loans come from banks, dedicated business lenders, and other organizations with the mission of helping businesses succeed. The main advantages of a business loan are that you have an extended amount of time to pay off what you borrowed. The downside is that you could lose your business if you are unable to keep up with payments.
Some things to consider when taking a business loan include:
- Interest Rates - Interest rates can be either fixed or variable, depending on the lender and the type of loan you are receiving. It is a good idea to negotiate the best rate you can to limit the total amount of money you will be repaying. Unlike consumer lending, business lending tends to be a bit more flexible in this area.
- Collateral - Because business loans tend to be fairly sizeable, they are also secured through collateral offered by the business owner. For a start-up, that collateral could be a home or some business equipment the owner already possesses. For existing business, that collateral is usually the company assets.
- Public Funding - There are times when government schemes allow for borrowing among small businesses. If you can find a government scheme for your needs, you'll probably get a more favourable interest rate than you would from a bank. The schemes often come with strings attached, so make sure you know what they are.
According to Better Business Finance, a business angel is a high net-worth individual who invests on his own or in partnership with a group. Business angels most often associate themselves with start-ups they believe have great potential. They usually offer their own expertise as a tool business owners can use to be successful.
The main advantage of the business angel is that they are genuinely interested in the success of your venture. If you fail, they stand to lose all of the monies invested in you. That means the angel typically does everything they can to help ensure the companies they are invested in succeed.
The disadvantage of the business angel could be realized if the investor attempts to exert too much control over your business. This does not always happen, but when it does, it can cause a great rift between investors and company owners. Finding an angel you can work with reasonably well makes this type of investing much easier to accept.
Business grants come from a number of sources including government agencies, trade groups, and non-profit organisations. They aren't as plentiful as professional grant writers would have you to believe, but they are available if you are willing to look for them. The best thing about the grant is that it is money that does not have to be repaid.
Here's what you need to know about grants:
- They Are Targeted - By definition, a grant is money targeted at a specific purpose. That is what makes them so difficult to come by. There may be dozens of business grants available in your local area yet none are targeted to your particular industry or business model. You may have to do a lot of searching before you will find grants appropriate for you.
- They Are Limited - Business grants are also not necessarily very large. Grant issuers are usually working with limited funds, so the amount they give to any one organisation tends to also be limited. It is unlikely that you will meet all of your financing goals just through grants.
- Grant Writing Is Essential - When you apply for grant, you have to convince the grant issuer that your business is worthy of receiving the money. Successful businesses use experienced grant writers to put good proposals together. If you have no experience in this area then you will need to learn how it's done or else hire a grant writer to do it for you.
- Matched Funding - While there are exceptions to every rule, the vast majority of business grants require applicants to match the grant money with their own funding. If you are already low on cash, this could be a challenge.
Investment financing is similar to using a business angel except for one important detail: you actually sell a share of your business to the individual or company offering you the finance. For this reason, investment financing is also known as "equity" financing.
The idea behind the equity principle dictates that you sell a portion of your business to the investor as a percentage of your total company. Let's say 20% just for purposes of illustration. As your business grows and expands the value of the investor's share also grows proportionally. When the investor is ready to exit your business, he or she sells their share back to the company or to another investor.
Investment financing is the model the private equity business is built on. The nice thing about this type of financing is that there are private equity companies covering just about every industry and all business sizes. Some even specialise in small-to-medium sized enterprises (SMEs) in niche sectors.
Like business angels, private equity investors are also very interested in the success of any company in which they invest. They will come alongside a company's management team to offer experience, advice, and direction. In some cases, they may even take an active role in company management if the size of their investment warrants it.
When companies have short-term financing needs, such as investing in new equipment or getting caught up on accounts payables, they sometimes use invoice financing. This funding source uses outstanding invoices as leverage to borrow money. There are two ways to do this:
- Factoring - The factoring model involves selling outstanding invoices to an invoice financier. The business will sell outstanding invoices for a reduced percentage of their total value; let's say 80% as an example. When an invoice is paid, the financier will forward the remaining 20% to the company less any interest charges and fees.
- Discounting - Under this model, invoices are not sold the financier. Rather, the financier loans money to the business based on the total value of outstanding invoices. When outstanding invoices are paid, the money goes directly to the financier who then subtracts principle, interest, and fees before returning the remaining balance to the company.
Understand that businesses using the factoring model will be making it known to their customers they are utilising invoice financing. This is because invoice payments are made directly to the financier rather than the original business. Owners who do not want their customers to know should not use the factoring model.
It's also important to understand that invoice financing may prevent a business owner from procuring a business loan or another form of financing requiring collateral. This is because invoice financing reduces the "book value" of a business. Without that book value, lenders may not be willing to take the risk.
Another great tool for short-term financing is an overdraft service provided by a bank. This service allows the business owner to spend more money than they have in their account in order to meet short-term needs. However, overdraft service should NEVER be used for long-term financing for the following reasons:
- higher interest rates
- higher potential for damaging credit rating
- greater chance for crippling future borrowing options
Asset Lease Financing
The last financing option does not provide any direct cash for your business, but it does free up cash you might spend purchasing new equipment or other assets. By using a lease, you can pay for new assets over time rather than having to come up with all the money up front.
Leasing also affords you the opportunity to get high quality equipment you may not have been able to afford through a purchase. As long as you make all of your payments, the leasing company cannot repossess the equipment. If you default on the lease you may lose the equipment, but none of the rest of your assets will be touched.
The downside to leasing is the fact that you never truly own the equipment. That means you could spend substantially more in the long run if you end up never purchasing. It also means you cannot claim capital allowances for leases any shorter than five years.
As you can see, there are plenty of funding options for businesses in need of capital. Between all of the ones we have listed here, you ought to be able to find a few that meet your needs appropriately. Hopefully the right financing options will help your business thrive and grow so it does not become another insolvency statistic in the future.
Searching for business financing is not an easy task, to say the least. We want to help you by pointing you in the direction of companies willing to offer loans or other funding options. The following links will take you to some of those companies:
Barclays - One of the first names in UK banking offers flexible small business loans of up to £25,000. Get started by visiting this link and looking at all of the details. When you are ready, you can arrange for someone to contact you to discuss your needs.
HSBC - Another well-known name in banking, HSBC makes small business loans available to business owners who already have current accounts. It is easy to apply online or, if you prefer, you can speak a representative over the phone.
UK Business Angel Association - This is the place to start if you are thinking about financing from a business angel. The Association represents hundreds of angels investing individually and as a part of larger groups.
UK Credit Insurance Specialists - This website belongs to an independent financial services broker offering a number of financial solutions for small businesses. In terms of invoice financing, they offer both factoring and discounting.
UK Private Equity - This private equity firm is made up of a group of high net worth individuals desiring to invest in start-ups that do not yet qualify as SMEs. You might follow this link if you are looking for enthusiastic investors for your new business.
Liberty Leasing Plc. - Following this link takes you to the website of a privately owned finance house offering asset leasing and other opportunities. When you visit, you will see they cover a wide range of industries and asset types.
Close Brothers Leasing - A company offering asset-leasing solutions valued up to £20 million. They specialize in leasing options for medium-sized businesses in the UK.
UK Business Funding Centre - A website offering businesses the ability to learn about and search for government business grants. There is a lot of useful information on this site regarding how grants work and how to apply.
Boost Capital - The UK's first dedicated specialist financier dedicated to providing unsecured loans to small businesses. Loans are leveraged against a company's future credit card sales. They provide loans for retail businesses, restaurants, medical businesses, and more.
Money Supermarket - This site offers comparisons on business current accounts as well as recommendations from a number of partners offering a wide range of business and finance options. You can follow links directly to financing providers from this page.