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Complete guide to small business finance

7-minute read

Josh Hall

30 May 2013

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Finding finance is one of the most important tasks facing any small business owner.

It can seem like a daunting prospect, but all small businesses need to raise cash somehow. The way in which you achieve this will vary depending on the nature of your business and your personal circumstances. Some businesses will need more startup capital than others. Some will secure it more easily. But every business, regardless of its ambitions, needs to start somewhere. In this guide we will introduce you to some of the key ways in which startup businesses can raise cash. Some of these will be familiar, but others might be new. We start with a video summarising popular funding methods, and then go on to explain in more detail ways in which businesses may be able to finance themselves.

  • Advice and resources for UK small businesses

Friends and family

Friends, family, and personal savings remain amongst the most popular finance options for the UK's small businesses. In fact, research from Simply Business found that the majority of small firms rely on this sort of funding to get off the ground.

There are significant potential advantages to seeking finance from those closest to you. Perhaps the most important of these is that you do not have to deal with the banks. Your friends and family are likely to have a much better understanding of your business than the high street giants, and they are likely to be more understanding in the event that things do not go as planned. You are also almost certain to get a better rate from friends and family than you are on the high street.

Many of those who borrow from friends and family do so from those with existing business experience. This can also be hugely beneficial, particularly to first-time entrepreneurs, as these individuals can often contribute valuable knowledge as well as cash.

However, it is important that you treat finance from friends or family exactly as you would funding from a bank or other lender. Is the money a loan, or is it being invested in exchange for equity? How long is the term of the loan? At what rate is it being lent? When will repayment be expected? It is vital that you have these crucial aspects set out in writing before you accept the loan. You may wish to seek professional legal assistance to help you draw up this document. This might seem like overkill, but it will help to avoid the potential for misunderstandings, and can prove vital in ensuring that things don't turn sour.

Bank finance

Banks are still a key destination for businesses seeking cash, and it's worth remembering that many lenders have targets that they are expected to meet. If you believe that you have a viable business, and if you and your firm are creditworthy, then banks are worth a shot.

There are two key types of bank finance that you might consider: loans, and overdrafts. Loans are provided for a set term and will have an interest rate that is either fixed or variable - that is, it will either stay the same over the term of the loan, or it will change with the Bank of England's base rate. Loans have a number of distinct advantages. If you have a fixed-rate loan you will know exactly how much you need to repay each month, and on what date. You will know when the loan will be repaid and, in many cases, you might be able to extend it if your requirements change.

An overdraft, meanwhile, is more flexible. You are only charged for what you borrow - although you should understand that some banks apply flat fees for overdraft use within certain limits. Overdrafts are considered to be short-term funding arrangements. Furthermore, in contrast to a loan, your bank can demand that you repay your overdraft at any time - meaning that they are a more flexible but less secure funding method.

Banks will normally require you to submit a comprehensive business plan in order to prove that your business is viable and has a strategy for repayment and growth. In the case of a new or untested business, you should be prepared for the bank to also perform credit referencing checks on all of the directors. Funding decisions may be contingent on your perceived creditworthiness, as well as that of your business.

Peer to peer lending

Banks are no longer the only show in town. Over the last few years a series of alternative finance methods have been developed, and now they are coming to maturity.

Peer to peer, or P2P lending, also known as 'crowdfunding', is one of the most exciting of these. In these arrangements, private lenders make loans to small businesses through an intermediary network. Crowdfunding has been popular amongst investors as it provides an opportunity to lend to or purchase equity in exciting new businesses, and enjoy a good return. There is therefore a large and ever-growing pool of investors from which you might be able to draw.

There are several of these networks in existence; the best established include Crowdcube and Funding Circle. Crowdfunding platforms can differ significantly. Funding Circle, for example, will need to see at least two years' accounts filed at Companies House, and non-limited companies will need a turnover of at least £45,000 in the latest accounts. The restrictions on Crowdcube applicants, meanwhile, are not as stringent. To pitch, you'll need a UK or Irish limited company (not a sole trader or limited liability partnership) with a valid Companies House number. There are also a few restrictions around the kind of business you're in – property development, for example, isn't eligible.

There are a few really significant advantages to peer to peer lending. The first is that you don't have to deal with the bank – which many business owners see as a major benefit. Just as importantly, though, many businesses who use peer to peer lending find that the lenders are more sympathetic to the realities of running a business. It is common for lenders to take a more active interest in the life of the businesses with which they are dealing, and this can be beneficial. Finally, peer to peer lending is often cheaper than bank lending – but you should make sure that you approach these facilities just as cautiously as you would a conventional loan.

There are also drawbacks, the most significant of which is upfront cost. Although the rates you pay may be cheaper than those you can secure on the high street, it is important to understand that most crowdfunding platforms charge a flat fee on money invested. Similarly, some platforms place limits on the amount of time a pitch can remain live. You might, for example, have only three months in which to secure all of your funding.

Invoice financing

Invoice finance is a less well-known funding route, but it can be very useful – particularly for growing businesses. There are two types of invoice finance: factoring, and discounting.

In a factoring arrangement, you pass your unpaid invoices on to a third party, known as a 'factor'. They then pay you a proportion of the face value of the invoice. After this, they take responsibility for ensuring that the invoice is paid. When the invoice is settled, they pay you the remaining amount minus interest and administration fees.

In a discounting arrangement, you maintain responsibility for ensuring that the invoices are paid. The third party simply lends you money based on the face value of your invoices. When the invoices are paid, the money goes to that third party, and you pay them interest for the loan.

Invoice finance is potentially a very flexible way of meeting your funding arrangements but, by nature, it is not suitable for businesses that do not have any invoices. Many businesses still in the 'startup phase', however, use invoice finance to cashflow their ventures. Invoice finance is particularly appealing because it has the potential to grow with your business. It can also provide a potential funding source if you are concerned about being turned down for a loan because of a poor credit history.

As with all funding methods, though, you should be aware of the potential costs. Administration charges can vary significantly from provider to provider, and can make the difference between an affordable solution and an impractical one. Make sure that you fully understand the costs of invoice finance before you begin.

Equity finance

Equity finance involves selling a stake in your business. The investor who buys that stake will take on a portion of the profits or losses that your business makes. In addition, depending on the terms of the investment, you might have to consult with them before you make certain decisions. Equity finance is therefore a decision that should not be taken lightly.

However, there are some significant advantages to equity finance. First and foremost, you will not have to make repayments in the same way that you would if you took out a loan. Equity finance is an investment, and does not need to be repaid. If things do not go to plan and your business ultimately fails, the investors share the risk.

Just as importantly, though, equity finance is often not just about the cash. Instead, equity investors frequently have extensive business experience which they can bring to bear on your venture. Many equity investors end up playing a key role in the development of a startup, and this is one of the most important advantages to this method of funding.

The number of routes through which you might secure equity finance has grown in recent years. Several of the UK's most popular crowdfunding sites are, in fact, platforms through which small businesses can pitch for equity finance. Alternatively, there is likely to be an association of 'angel' investors based near to you. If you think you have a business in which an investor might be interested, you should get in touch with these organisations. Your local Chamber of Commerce will be able to tell you who to contact.

You should note, however, that many equity investors tend to look for firms that already have some proven track record. This method of finance may therefore not be suitable if you business has not yet launched, but could still be an option if your firm is in the 'startup phase' or looking to expand.

Government grants and loans

Finally, there is a range of grants available to small and growing businesses. These can be a great way of raising finance, for the obvious reason that they do not have to be paid back. However, the criteria for qualification can be stringent, and it can seem like a full-time job to simply seek out grants for which your business might be eligible.

Young people are particularly well-placed to take advantage of startup grants. The government-backed Start Up Loans Company is a good place to start, with cheap, unsecured loans that are generally extended on the basis of a strong business plan only. The scheme also offers an extensive business mentoring programme, helping entrepreneurs with practical issues like financial forecasts and growth strategies. Start Up Loans are administered by Delivery Partners across England. You can apply to contact your local provider on the Start Up Loans website.

If you are looking for cash to bring new knowledge and expertise into your business, you might choose to investigate the government's Innovation Vouchers. Under this scheme you can bid for cash to transfer new knowledge or skills into your firm, provided that it comes from a business from which you haven't dealt in the past. You can find more information about Innovation Vouchers through

It can be challenging to find a grant for which your business is suitable. The government's own business support finder can help you identify potential grants.

Regardless of the type of funding you choose to apply for, it is vital that you put together a comprehensive, convincing business case. You should be prepared to present a business plan to any potential lender or investor. You will need to show your projected numbers for several years in advance. You should also understand that some funding sources are only available to businesses of certain legal types. If you are yet to write a business plan, or if you are confused about legal structures, you can find more information in the Simply Business Knowledge centre, or you should consult an accountant or solicitor.

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