In order to expand, to grow and to stay financially robust, companies may need business finance.
A report to parliament on the 28th of December 2017 revealed that there are some 5.7 million businesses in the UK, of which 99% are small to medium-sized enterprises (SMEs). Almost a half of these have sought some form of external business finance within the past three years, says a further study by the publicly-backed British Business Bank.
That hunger for external funding has given rise to the development of a whole array of different forms of business finance – each having its respective advantages and disadvantages, making a sometimes bewildering choice between the various sources.
This guide offers an overview of some of the most common types of business finance and considers which might be appropriate for the needs and requirements of a particular enterprise at its given stage of development. The focus is on limited liability companies, rather than the myriad of sole traders and the self-employed.
After first taking a brief look at why your company may need business funding, therefore, this guide, looks at sources of funding through:
It may become clear that some sources are tried and tested traditional methods of funding your company’s growth and expansion, whilst others offer innovative and imaginative new ways of securing the external finance you need.
There may be times when a business needs additional working capital, for example:
The list is by no means exhaustive – there are many reasons why you may need business funding.
Here are some of the many different types and sources of funding which are available to companies in search of external funding.
Small businesses in the UK have traditionally turned to their local bank for the funding they need.
But past relationships where your high street bank was working hand in glove with a variety of local businesses is probably long gone – if nothing else, the banks themselves are disappearing from many of those high streets.
Since the financial crisis of 2008, banks also appear to have become more risk averse when it comes to lending to businesses. As a result, application procedures tend to have grown more complicated, inevitably requiring a detailed business plan in support of the requested funding, whilst decisions may take longer to come through – a delay which, in some circumstances, may defeat the whole object of seeking finance.
Banks may be prepared to offer either secured or unsecured loans. The latter typically take longer to arrange – because of the security involved – and of course, leave at risk the company or directors’ assets which may have been pledged as security.
Secured loans may be suitable for companies looking to raise substantial amounts over the longer term – for the purchase of new premises, for instance. The most common example of such secured borrowing, of course, is a commercial mortgage, where the security on the loan is the property itself.
One of the principal reasons for seeking external finance is for the company to purchase necessary fixed assets, such as major machinery or equipment used in its production processes.
Asset finance represents a way of obtaining such assets through their lease or hire purchase. This avoids the long-term commitment of immediate or outright purchase, and because the assets themselves are used as security against the credit advanced, no further collateral (from the company or its directors) is typically required, explains the Business Finance Guide published by the Institute of Chartered Accountants in England and Wales (ICAEW).
If the assets are leased, they do not come into the company’s ownership; and if they are bought on hire purchase, ownership does not pass to the company until the final payment instalment has been made. For some companies, there may be accounting (and taxation) advantages in acquiring assets through profit and loss expenditure, rather than their appearing in the balance sheet.
Credit arrangements involving asset finance are typically provided by lenders who are also members of the Finance & Leasing Association (FLA), which offers a degree or confidence and reassurance to the lender since members must adhere to a strict “lending code”.
The sources of finance so far considered fall under the broad classification of debt financing – your company raises the external funding it requires by borrowing from a lender.
Private investors – individuals, groups of individuals or other companies – may be prepared to offer either secured or unsecured loans, but the more common arrangement is through equity finance. Just as the term suggests, this involves the private investor advancing funds in return for a stake in your company – a share in its ownership or equity.
Also called angel investors, they may be the source of substantial external funding, but the price you pay is in sharing ownership – and along with it, typically, a significant say in your company’s decision-making. The larger the investment you are seeking, the greater share in the equity of your company is likely to be demanded in return.
Angel investors are likely to take an exceptionally keen interest in the business case you are able to make for expanding your company or using the funds they make available for particular projects. Expect very searching questions to be asked. Among the leading organisations of angel investors in the UK are the Angel Investment Network and the UK Business Angels Association.
To see a more or less realistic demonstration of angel investors in action – and the considerations they might take into account before deciding to invest in a company – you may do worse than watch an episode or two of the popular television programme, the Dragons’ Den.
Crowdfunding is a relatively recent phenomenon and is an apt description for the way in which a whole group of unrelated people – a “crowd” – may raise funds for an individual, a company or for a charitable project. In theory, it allows you to use the power of the internet to get in touch with potentially millions of donors, lenders or investors.
There are a number of variations on the theme. Probably the most widely seen are those set up to encourage donations to a charitable cause. In return for their donations, individuals or corporate donors receive recognition for their charitable act and may also receive a token “reward” (of relatively low financial value).
But there are also loan-based and investment-based crowdfunding schemes. Just as the terms suggest, these involve groups of individuals or companies each investing in a for-profit enterprise for a share in its anticipated financial success or lending the enterprise money in return for the interest earned on that lending.
Neither donation nor reward-based crowdfunding schemes are regulated by the Financial Services Commission (FCA).
Loan-based and investment-based crowdfunding schemes, however, are regulated by the FCA, explains the government-backed Money Advice Service. Regulation followed a concern by the FCA about the risks involved in loans and investments made by way of crowdfunding sources and the commissions charged by the online platforms set up to bring together individuals wanting to lend or invest their money in this way and the companies and organisations looking for such funding.
A merchant cash advance is obtained by a specialist lender purchasing your company’s anticipated future credit and debit card sales.
You benefit from the unsecured advance and, in return, pay the provider a pre-determined percentage of the transactions your customers make via credit and debit cards. Because the advance is unsecured, you need offer no collateral by way of company or other assets.
The merchant cash advance provider, of course, takes a risk that anticipated credit, and debit card sales do not achieve the expected returns, but if the loan takes longer than initially envisaged for you to pay off, the agreed repayment terms and amount remain the same.
In some ways, a merchant cash advance is similar to invoice factoring, where a factor purchases the debts owed to your company as represented by the invoices you have issued. The advance is equivalent to most of that total debt, although the balance may be held back until the factor has successfully recovered all that is owed by your customers
A factoring agreement may also make provision for the management and writing off of bad debts.
Invoice discounting is similar to factoring in that it represents an advance against your company’s issued invoices, but you retain control of your sales ledger, and customers need not know that an invoice discounting provider has been commissioned by you.
Given such a wide variety of potential sources of funding – some of which may involve you needing to jump through more hoops and prepare detailed business plans and projections before a long drawn out consideration of your application – many businesses are looking for funding that is easier and much faster to obtain.
The latest innovation created in response to such demands is peer to peer lending – or simply P2P lending. According to the Institute of Chartered Accountants in England and Wales (ICAEW), the UK is in the vanguard of the spread of this innovative, alternative form of online finance.
P2P lending again harnesses the power and reach of the internet by matching lenders with borrowers – you do not need to scour a huge range of different sources, comparing interest rates and repayment terms, since the P2P provider does all that on your behalf.
The business finance raised in this way is unsecured borrowing – so no collateral needs to be found, and an assessment of your borrowing capability is made on the strength of your current business performance and creditworthiness.
The amount you may borrow of course varies from one P2P provider to another but typically ranges from just a few thousands of pounds, up to as much as £100,000. The average amount borrowed by the typical company, however, is probably somewhat less than £50,000.
Some lenders may also express the loan in terms of the amount borrowed, plus a single additional sum representing the whole of the credit charges made. This results in a simple and straightforward repayment schedule of known, fixed amounts each month – making management and control of your company’s cashflow significantly smoother.
In addition to the simplicity, ease of management and ready availability of P2P business finance, a further attraction is the speed with which it may be arranged online.
To help meet the challenges of an increasingly fast-moving business environment, for example, it is now possible to make an online enquiry about borrowing up to £100,000 (or whatever amount you choose), over a given period, and to receive a decision almost immediately.
If your application is approved in principle, this is followed by the lender’s consideration of the formal application, to which a decision may be given and the funds transferred electronically to your business within little more than 48 hours.
Peer to peer lending may be the way of cutting through any uncertainty, by opting for simple and straightforward unsecured borrowing that may be quickly arranged.
At various stages of their development and progression, most businesses need access to external funding – by way of equity or debt funding.
Given the loss of independence and decision-making almost certain to be attached to equity funding, debt finance is the course chosen by many businesses looking to grow and expand.
Hopefully this brief guide will help you make an informed decision as to the business finance solution most likely to be suitable to your present needs and circumstances.