Where can I find the cash I need to finance my business?

Raising the necessary cash for your business isn't just about going to the bank and seeing how much they'll give you. There are numerous sources of funding and each one has its advantages, disadvantages, and appropriate uses...

Personal savings and assets

Your own bank account is a logical place to look when seeking money for your new business. If you're not prepared to invest in yourself, then why should
anyone else?

The money could come from your savings, a second mortgage, a windfall such as a maturing ISA, an inheritance, or a redundancy payment.

Unlike more formal types of funding, there are obviously no restrictions on how you spend your own money or use personal equity. Cash in the bank can be a useful source of working capital to help during the first few months. However there is one important rule you should follow, only consider securing a loan against personal assets such as your home if you want to make a long-term investment in your business. You can then factor the repayment costs into your business plan.

Finally, be as wary of using your own cash as any other investor would be. Draw up a proper business plan, calculate a realistic rate of return, and decide objectively whether or not it is a sensible use of your money.

 

Friends and family

Asking your friends and family for money is one of the most common ways of funding a business - especially a new venture which, without a track record, may find it difficult to get funding elsewhere. Dealing with family and friends can often be the easiest way to secure funding as they already know and trust you.

You should ask for either a loan or an investment. If it is a loan you should agree a fixed repayment period and rate of interest. If they make an investment they will hold equity in your company in the form of profits. They will expect a percentage of the profits and the ability to sell their stake in the business, to you or a third party, some time in the future.

A word of caution, these are the people who you love most in the world. If you lose their money or have an argument over the business it could damage your relationship with them. It is important that any loan or investment should be underpinned with a legally-drawn up agreement spelling out everyone's liabilities, obligations, and expectations. You should make sure that everyone involved fully understands this document to avoid problems later on.

 

Bank overdrafts

An overdraft is an agreed amount that your bank will let your business borrow without notice. In turn you pay interest on the sum borrowed and possibly a service or set-up charge. Interest is usually calculated on a daily basis so you only pay for what you actually borrow.

This facility is ideal if your business will face uneven demands in its finances. This could be due to seasonal fluctuations in trade or the fact that you have to pay suppliers before you receive payment from customers.

Overdrafts are quick and convenient to arrange and they are flexible, you only have to use them (and therefore pay for them) if you need them.

Your overdraft should only be used to temporarily pay for day-to-day business running costs such as paying bills and wages or buying stock.

 

Bank loan

The bank is often the first place many would-be business owners approach when they want to start a business. You should be aware though that banks are risk averse, unless you can offer some form of security it can be difficult to persuade them to invest in an unproven new business.

As a brand new business, you may well not have any such security to offer, in which case you may be entitled to take part in the Government's Small Firms Loan Guarantee Scheme. Alternatively you may be able to take out a smaller, unsecured loan as long as you can persuade the bank you will be able to generate a steady and predictable cash flow.

Bank loans are normally used as a source of investment or long-term capital rather than working or short-term capital. Remember, loan repayments must be made month-in-month-out, no matter how well your business is doing. If you cannot meet the repayments on a secured loan you run the risk of losing whatever it has been secured against.

 

Credit cards

Credit and charge cards are a flexible and convenient short-term means of borrowing cash, paying bills and making purchases, regardless of how much is in your bank account.

Using a credit or charge card probably means you have to write fewer cheques (reducing your bank charges). It is a fast and convenient payment method and can give you up to 56 days of free credit. The itemised billing means that you can analyse your spending patterns quickly and clearly and this can help with your bookkeeping.

Competition in the credit card market means that there are currently a number of companies offering 0% interest on balance transfers. Many small businesses are taking advantage of this by continually transferring their balances from one card to another, effectively borrowing for nothing.

There is often a fixed annual charge and if you don't clear your monthly balance within the specified time, you will incur hefty charges. Credit cards should only be used as a short-term funding solution and you may find that a bank loan is a more suitable option if the borrowing is ongoing.

 

Mortgage

A mortgage allows you to borrow money and use it to buy property. It is intended as a long-term loan - usually at least 10 years - and is secured against the property it is used to buy. So if you can't meet the monthly repayments you will lose the property.

The amount you are allowed to borrow will depend on how much you can put down as a deposit, your credit record, the value of the property you want to buy and, crucially, the projected income for your business. A lender will only advance you money if he believes you will be able to afford the repayments.

A mortgage is an ideal way of raising long-term investment capital, but you should avoid using it to fund day-to-day working capital.

If you expect your business to expand quickly you may find yourself needing bigger premises before you have paid off a significant amount of your mortgage. If you are likely to keep moving premises, a mortgage may be a false economy and renting or leasing may be a better option.

If you can't afford the monthly repayments, the mortgage will be foreclosed and the premises sold to pay off the loan. If the proceeds of the sale aren't enough to cover the remaining sum, you will liable for the additional balance.

 

Venture capital

Venture capitalists (VCs) are professionally-run fund management companies prepared to give potential high-fliers significant backing.

VCs invest money, rather than lend it, in return for shares in the business and probably a seat on the board. They specialise in providing potential high-fliers with the backing they need to get started.

VCs look for businesses that offer something genuinely new with a proven market and fast growth potential. Investors normally look for a minimum return of between 30 and 40% per annum over five years.

 

Business angels

An informal venture capitalist, a business angel is a private individual who is willing to provide equity finance to a small business. He or she will receive shares in your business in return for providing cash to start up your venture. They may also be prepared to share their experience, advice and contacts to help your business really take off.

Potential sources of business angels include your bank, your local Business Link, or one of the matchmaking organisations that exist to bring the two sides together.

To attract a business angel you will need to draw up a detailed business plan which demonstrates how your business will achieve significant growth over the next three to five years and that it has a strong management team.

Once you've found a potential investor you need to establish terms upfront. This should include when they can sell their stake and to whom; whether you have first option to buy; how often they can expect to receive a dividend and the level of control or input they are expected to make in the day-to-day or strategic running of your business.

 

Grants

There are numerous grants available to small businesses from the EU, central and local government, and a wide range of organisations and trusts. Every grant is different. Some will take the form of interest-free loans; others will be free grants of cash; or they could be grants in the form of advice or business support.

Grant qualification depends on factors such as your businesses location, size, area of expertise, and needs. If you set up your business in an economically-disadvantaged region you are more likely to qualify.

See the article on grants and awards for more information on this.