How to make a million
Whether you’re happy keeping your business small but perfectly formed or have your sights set on the sta...Read More
All businesses, large and small, have times where some extra cash would make things easier. However, getting funding is easier said than done, and many businesses struggle to secure extra finance, or are put off by the perceived difficulty before they even start.
In this article we’ll look at common reasons to take out extra finance, and what options are available to small businesses.
Small businesses accounted for 99.3% of UK private sector companies at the start of 2016. Source
Businesses have a less than 20% chance of being accepted for funding Source
Start-ups, defined as less than five years old, had a 50 per cent rejection rate from banks (Source)
Banks still account for more than 80 per cent of lending (source)
The alternative finance sector, including peer-to-peer lending increased by 75 per cent in 2015. (source)
60% of SMEs sought some sort of external funding in the last 3 years (Source)
78% of small firms admitting to being too risk-averse to look for external investment. (Source)
There are a number of reasons that a company might apply for finance. Some of the most common are summarised below…
Working Capital/Cash flow
Working capital loans help businesses to weather lean times. They literally ‘keep the lights on’ – being used to pay for essential day to day expenses such as electricity bills and salaries. Many businesses use working capital loans in their early years to cover the gap between invoice payments.
Working capital loans are typically short term and for relatively low amounts. You should be confident that you’ll be able to repay the full amount once business picks up – the loans shouldn’t be used to plug a hole you can’t get out of.
Working capital loans tend to be granted based on predicted future performance. As you would expect with a short term loan, payments must be made regularly, sometimes daily.
Starting a business
Online endeavours typically require little initial capital, however some businesses would never get off the ground without a hefty injection of cash. To get initial funding you’ll need a business plan, or clever hook if you’re going the less traditional route. You may need collateral to secure the loan against. Most commonly this would be your home, but think carefully before taking this route, as anything you use as collateral is liable to be repossessed if you can’t keep up with repayments.
Some businesses use loans to buy stock. This is particularly common in early stage businesses, who don’t have money in the bank to invest into products. Inventory loans can also be used by companies who are expanding into new sectors or markets. Of course you have to be very confident that the investment will pay off – that you will actually be able to sell all the stock you buy. The loan is likely to be secured against your stock, however the loan provider has to be sure that they could sell the stock if you couldn’t. For this reason getting accepted for this type of loan can be tricky.
Debt restructuring loans are used by companies who’ve had a run of bad luck, and can’t afford to keep up with repayments on their existing debts. Demand for these loans tend to peak in tough economic times, when firms struggle just to keep going. Debt restructuring loans essentially keep a business going. They can help a business avoid bankruptcy, satisfy creditors and ensure that relationships with suppliers don’t sour. Obviously any lenders would want to be sure that circumstances wouldn’t repeat themselves so a strong business plan is a must.
Expansion and assets purchasing
For successful businesses looking to go to the next level, a loan can be used for expansion and assets purchasing. These loans tend to be for relatively high amounts, are taken out over the long term and are seen as more secure – you’re only likely to apply if your business is already flourishing. However, you will still need to show that your projected profits will cover the cost of the loan. Make sure that you get any funding in place before you actually begin expanding – you wouldn’t want to take on a new hire only to have funding fall through at the last minute.
Questions to ask before seeking finance
Whatever your reason for taking out a loan, there are some questions that you should always ask before seeking finance. Answering these questions will help to choose what sort of loan you want, and from what sort of lender:
Finance can come from a wealth of different sources, each with their own pros and cons. Below are some of the most common suppliers:
Private Equity finance can come from venture capitalists (VC) or angel investors. Angel investors are successful entrepreneurs who wish to invest their own money in up and coming companies, whilst venture capital tends to come from businesses as opposed to individuals. Companies that attract private equity investors tend to have high growth prospects, for this reason private equity investors tend to be particularly attracted to the tech sector.
Angel investors invest a smaller amounts than VCs – usually between ten thousand and 750 thousand. VCs can invest millions.
Because they are investing in your company, rather than giving you a loan, VCs and angels will be hands on in a way that a bank would never be. If you manage to secure private equity investment you can expect to give up a share of your business meaning you will have investors to answer to, investors who may have strong ideas about how your business should be run. The pressure to make profit may intensify, as investors will have a set exit point – by which point they will expect to have seen a return on their investment. On the other hand, angel investors in particular tend to provide their considerable expertise and contacts to the businesses they invest in.
Crowdfunding is exactly what it sounds like, and has seen some great successes over the last few years, including a smartwatch which raised over $20,000 and a card game that raised over $8,000.
The most well known crowdfunding platform is Kickstarter, which allows the general public to easily donate money to an idea. Higher donors usually get something for their money, whether that’s access to a service, a product sample or branded merchandise. Whilst crowdfunding platforms provide easy access to no strings cash, they tend to only really take off for quirky or innovative business ideas.
Peer to Peer
Peer to Peer lending matches matches individuals and businesses with borrowers. The sector has seen massive growth, with lending doubling year on on year. In fact, this type of lending is the bedrock of the UK’s alternative finance sector. Acquiring money via a peer to peer network is a relatively simple process and provides quick access to cash – sometimes in as little as a few days. Peer to Peer lending can be both secured and unsecured. Secured loans are usually secured against property or or future invoice receipts.
Grants are the most coveted source of financial assistance, because you don’t have to pay them back. There are a huge variety of grants within the UK – meaning it’s always worth checking if you’re eligible. Types of grants include:
Sector wise, science, innovation and tech companies see a lot of grant programs, however specific regional areas are also often singled out.
Banks are the most traditional source of finance and, whilst securing bank finance can be tricky, it does have its benefits. Bank lenders are highly regulated, and as such you’ll have to jump through a lot of hoops – you’ll be expected to produce detailed business plans and cash flow forecasts. Interest rates may be higher than other forms of lending, and may need to be secured. However, you won’t have to give up ownership of your business and there are a variety of ways to secure finance from a bank, including loans, extended overdrafts and credit cards.
Targeted specifically at new businesses, startup loans are Government backed loans with a low interest rate of just 6% p/a. Businesses can borrow between £500 and £25,000. Loans are repaid on a monthly basis over a period of between one and five years. Successful applicants can expect to receive mentoring and business support on top of their loan amount. What’s more, startup loans are unsecured, meaning you don’t have to put any assets at risk when you take one out.
This might not be the first funding method to spring to mind, but competitions can be a great way to access funds and business advice as well as generating some positive press. Examples of funding competitions include the Shell Livewire Smarter Future Programme, Ernst and Young UK Entrepreneur of the Year and the Nectar Business Small Business Award. A list of different competitions (including those mentioned) can be found here.
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