Different funding sources for business

Different funding sources for business

Different funding sources for business

Raising funding is something you may have to keep doing whatever the state of your business – if you’re starting up, wanting to grow your business fast or expand it.

For small to medium sized (SMEs’), raising funds can be a difficult process since they may not have enough assets or trading history. If you’re starting up a business, it can be even more difficult and frustrating.

Whatever the reason for raising funds, it will be necessary to prepare a business plan, which will be the key tool to convince banks or investors to lend or invest.

The following sources of funding should be investigated, depending on the circumstances and there are pros and cons which should be carefully considered:

  • Existing cash flows
  • Existing shareholders
  • Family and friends
  • High street banks (short to medium term loans)
  • Factoring and invoice discounting
  • Asset finance leasing or hire purchase
  • Merchant banks (medium to long term loans)
  • Business angels
  • Venture capital
  • Other funding (grants and soft loans)

Existing cash flows

This is the cheapest form of funds and you should investigate how you can improve your existing cash flows. Managing your cash flows more effectively may save you expensive external funds as well as keeping the ownership of the company undiluted.

Existing shareholders

If you still need more funds and the current shareholders can afford it, this source would be preferable. If there is reluctance to invest further rather than a lack of funds, then a bank or an external investor may not be interested either.

Family and friends

This is usually a source for SMEs’ which find it difficult to get banks or external investors to invest. However, if you introduce family or friends into your company, make sure you draw a legal shareholders’ agreement.

High street banks – short/medium term loans

The most common source of finance is to borrow money from a bank, although this has dried up in recent years. Usually, these would be secured on the assets of the business or even the personal assets of the business owners. Banks will usually want to evaluate your business plan. The interest paid on a loan would be dependent on the risk perceived by the bank but for most SMEs’, this would be 2% above the base rate or above (there will also be a small arrangement fee). A bank can force a company into bankruptcy if repayments are not kept up.

Factoring and invoice discounting

For the larger business, this may be an option and all the big banks do this. In return for a fee, the bank will advance you a large portion of your customer invoice (about 80%) within a few days of billing and then pay the balance when collected. Effectively, you will outsource your credit control to the bank, which scan affect your customer relationships.

Asset finance leasing or hire purchase

This is a common method of financing machinery and equipment and again the banks’ attitude to lending will depend on the trading history and the business plan. There are different methods of leasing from operating leases where the bank owns the equipment to lease/hire purchase where the business will own the equipment – it very much depends on the type of asset you want to lease. Operating leases are usually cheaper since the banks’ can get tax benefits from owning the asset.

Merchant banks – medium/long term loans

These are more suitable for the larger business transactions and for acquiring businesses.

The terms may be more favourable than the high street banks and some specialise in industry sectors.

Business angels

Business angels are wealthy individuals who usually have run their own businesses and want to help other businesses to expand or start up by investing in them. They would fund the smaller business and would be helpful in networking and advising you on running your business but would usually not get involved in the day to day running of it. They would have a time span in which they would want to exit and take their profit.

Venture capital (VCs’)

Usually, venture capital funds would invest £5m or more in established businesses, although there are funds that invest in start-ups and SMEs’. VCs’ have investment criteria and would have an exit plan, which is usually 5 years. You may lose control of the company and also may have to sell the company eventually, which means aligning your interests with those of the VC. There are business angel networks and VCs’ in various geographical areas and a useful web site is www.bvca.co.uk (British Venture Capital Association). Both VCs’ and business angels would want due diligence carried out on your company and the business plan by accountants.

Other funding

There are a variety of grants depending on the industry sector and looking at www.direct.gov.uk is a good start and ask your accountant.

Summary

As a general guide, if you’re looking to raise anything up to £2m, then look at business angel networks, bank debt, regional VC funds, the small firms guarantee scheme.

If you’re looking for more than £2m, then look at VCs’ and bank debt. Raising funding is not easy, can be time consuming, complex and can take from 3 to 12 months.

Key tips:

  • Prepare a business plan that identifies for what and how much funds you need
  • Seek advice from your accountant as to what funding sources are appropriate
  • Raise as much funds internally as possible by improving cash flows
  • For debt, make sure the business can make the repayments and negotiate the best rate
  • For equity from VCs’/business angels, make sure that you can work with them and that both your objectives are the same since you may be giving up control of your company

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