How to finance your business: a guide to the funding options


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funding options

Whether you’re a start-up, early stage or established business, there are an increasing number of external funding options available to help you get off the ground or grow. According to the 2017 Business Finance Survey, SMEs are now shopping around more when looking to raise capital, with fewer considering only one provider and consulting only the ‘big four’ banks.

Determining which source of finance to use will come down to your business’ individual needs and circumstances. Here are a few factors to bear in mind:

  • How much will the finance cost? This includes interest, arrangement fees and ongoing costs.  If you’re taking on a loan, what are the repayment terms?
  • Is it only money that you require? Or would you also benefit from the expertise of an investor?
  • How much money do you need? Will the funding cover the full cost of a project or only part of it? Will you be able to combine it with funding from other sources?
  • What are the terms and conditions? Could there be restrictions on getting funding from other providers?
  • How soon do you need the money? Some finance methods will have a longer application process than others.

 

To help, we’ve summarised some of the common funding options below and when you might consider using them. Most fall into one of two categories: loans or equity financing. Loans involve borrowing money to be repaid with interest, while equity involves raising money by selling shares in the business.

Bank finance

The high street banks offer a number of borrowing options, including:

  • Bank loans

As with most loans, your business borrows a sum of money and repays it with added interest. Loans can either be secured, meaning that you pledge an asset as collateral (for example property or machinery), or unsecured, which allows you to borrow without using assets. As secured loans involve less risk for the bank, interest rates are typically lower than for unsecured loans, and you can usually borrow larger amounts.

  • Invoice finance

Invoice finance is a way to release the money tied up in outstanding invoices. Rather than waiting for customers to pay, you get the money upfront and pay a percentage of the invoice amount to the lender. This can be an effective way of improving cash flow, enabling you to pay staff and suppliers and reinvest money in growing your business.

  • Business overdrafts

A business overdraft is a borrowing facility which allows you to access extra funds outside of your available bank balance up to an agreed limit. Interest rates are charged on the amount overdrawn and will usually be slightly higher than those you would pay with a standard business loan. Overdrafts are generally used for short-term financing requirements, for example to manage fluctuations in cash flow or to cover unforeseen expenses.

Asset finance

If you need access to new equipment or machinery, asset finance allows you to spread the cost and avoid cash flow problems. You can either rent the asset over an agreed period of time (leasing), or you can choose to buy and own the asset (hire purchase). Both options involve making regular repayments, usually at a fixed interest rate. Hire purchase will also usually require a nominal fee at the end of the lease term in order to gain ownership of the asset.

Crowdfunding and peer-to-peer lending

Crowdfunding involves pitching your business idea or project on a crowdfunding website in order to raise small sums of money from a large number of people. Individuals or organisations can invest in return for shares in the business (equity-based crowdfunding), or for a reward which you define (reward-based crowdfunding). Peer-to-peer lending is very similar to crowdfunding but is debt-based, meaning that you repay your investors with added interest. The lending is usually unsecured, and interest rates will depend on your credit rating. Crowdfunding may therefore be a more suitable option for your business if you are less established and/or considered to be higher risk.

Angel investors

If you don’t want to take on debt, equity financing could be a better way to raise capital. Angel investing is one type of equity finance, whereby investors use their own personal finance to invest in the growth of your start-up or early-stage business. This is normally in return for shares (an equity stake) in the business. Angel investors could be a high net-worth individual or a group of investors who pool their resources together. In addition to their funding, they can provide valuable experience and contacts. The amount invested is typically anything from £10,000 to £500,000, but can be higher if multiple angels come together.  

Venture capital and private equity

Other sources of equity financing include venture capital and private equity companies. These invest in businesses, help to accelerate their growth, and later make money out of selling their shares in the company. The main difference between the two is that private equity companies tend to invest in more established businesses, while venture capital companies usually invest in start-ups with high growth potential.

Government grants

Grants are non-repayable sums of money given to your business by the government, usually to fund a specific project rather than for financing general business activities. Many grants are aimed at specific sectors, or dedicated to promoting economic growth in particular regions. A grant usually covers only part of the total costs of a project, and you might be expected to match funds.  For business grants in Wales visit Business Wales.

Friends and family

One of the most common sources of funding for start-ups is friends and family, whether in the form of gifts, loans or equity investments. The finance provided by your personal network is likely to be relatively flexible and can be a good solution to help you get your business off the ground. It’s important that it is treated as a formal financial arrangement, which includes presenting a business plan, getting professional advice, and creating a written agreement. 

Development banks

The Development Bank of Wales is the only one of its kind in the UK and a unique resource for Wales. We provide loans and equity investment for Welsh businesses up to £5 million, and can lend or invest alongside the other types of finance providers previously mentioned (banks, crowd funders, grants, investors and other lenders). We also manage Angels Invest Wales, the largest network of angel investors in Wales. If you would like to know more about how we can help, contact us today.