To raise money to grow your business, you have to convince likely lenders that your idea is profitable, or at least has the potential to be.
Here, we take a look at two the two key elements that should drive your search for funding;
- The different types of finance available
- What lenders and investors look for in businesses
This guide helps you to understand more about the main types of business finance available, and also highlights what investors and lenders look for in a business before they lend it money.
1. The different types of finance available
There are many different types of finance available, depending on your needs and goals. Raising cash for day-to-day needs (working capital) is quite different from raising money for a long-term capital project – say, for buying new machinery or property. You need to be clear to financiers about the way you intend to invest the money.
Sources of finance include:
- Credit from suppliers.
- Leasing or contract hire.
Taking credit from suppliers
Credit is, in effect, borrowing from your suppliers and can take many forms. The most basic – payment terms – simply involves negotiating a set period of time before you have to pay suppliers.
Payment terms tend to be standard. Large or long-standing customers may be able to negotiate better terms.
Credit can help with cashflow but don’t consider money on credit as capital eg to buy a new car or carry out property improvements. Effectively, all you have done is delay payment – you still have to pay your suppliers, and pay VAT on sales (if you are VAT-registered).
Many small businesses use a bank overdraft. It’s a flexible way to cover short-term, day-to-day business requirements, for example, if the obligation to pay occurs before the receipt of the price on sale.
If your account remains overdrawn for a long period of time, an overdraft is probably not your best finance option as you could end up paying a lot of interest. There may be alternatives you can discuss with your bank.
Remember, too, that an overdraft is repayable on demand.
Loans are the traditional source of finance for small businesses and are usually used to finance buying assets and to meet other longer-term capital needs. With loans, you know how much you have to pay back, for how long. You may be able to negotiate repayment terms and interest rates.
Banks are the obvious, safe option to find a loan. If your bank won’t give you a loan, it may be for a very good reason that you need to consider, such as a flaw in your financial planning. Read these guides for more help and tips on being successful when applying for a busienss loan;
- How to maximise your chances of securing a small business loan
- The secrets of getting a business bank loan
Bear in mind that lenders may require security, or that the loan is backed by some form of personal guarantee – failure to make payments can have serious consequences.
There are other specialist sources available, but these are best considered only if you have experience of the financial sector.
If family and friends lend you money, make a formal agreement on paper so that everyone knows where they stand.
Leasing or contract hire
Leasing or contract hire are simple ways to fund the purchase of capital items like machine tools, cars or computers. Effectively, you hire the equipment over a long, fixed period at a preferential rate. Several types of arrangement are available, each with its own tax implications.
Factoring and invoice discounting
Factoring releases cash to boost your cashflow, using your outstanding invoices as security. As soon as you raise an invoice, the factor releases up to 90 per cent of its value to you, before your customer pays. When the invoice is paid, the factor pays you the balance, minus a charge.
Factoring lets you release cash tied up in unpaid invoices. This can help your business if it needs additional working capital. A related alternative is invoice discounting: here you collect the money, so your customers aren’t always aware you have borrowed money against their debt. You can learn more in;
One way to raise extra capital is to sell shares in your company to workers, family, friends, the public, or professional investors. They become partial owners of the company. Their rights will depend on any agreements made between shareholders and the proportion of the capital sold.
Typically the managers of a business should own a substantial equity stake. This means they have a personal interest in its success, which reassures other investors too.
Other shareholders may include investors who are not involved in day-to-day business affairs, but they can often be very vigilant, expecting a regular return on their investment. If they don’t see a regular return, they may use their voting rights to make changes in the business.
Private investors – or business angels – also invest money in return for equity. Some want the kudos of being involved without taking an active role; others may be more hands-on, investing expertise as well as money. Some angels become employees. All are looking for a return on their investment, usually within three to five years.
Venture capitalists are often prepared to make significant investment in return for equity. They are looking for businesses with a solid business plan and a good track record – typically with at least three years’ trading and turnover of at least £1million.
For more detailed help on raising funding by selling part of your business read;
- A Guide to ‘Alternative Finance’ – the new funding options for startups and small businesses
- 10 Top tips to ensure your crowdfunding efforts are rewarded
- 5 things you should know if you want to attract business angels
Grants come in all shapes and sizes, from Europe, Westminster, the Scottish Parliament, the Welsh Assembly and local authorities. Such is the available range that there are specialist consultants who can advise you on which grants to apply for. Business Link (or equivalent) can also advise. The web is a good source of grant information.
Most grant providers are looking for two things:
- Growth in your business – Providers want to be sure that the grant will lead to additional economic activity and provide an opportunity for growth you could not otherwise achieve.
- Viability of your business – Providers want to see that the additional economic activity the grant generates will be self-sustaining.
When considering making an application, bear in mind that:
- Grants can often be complex and time-consuming.
- It can be expensive to pay professional fees to help you meet grant requirements.
- Even if you qualify for a grant, there could be a lengthy delay before you receive any money, potentially leaving the project in limbo.
2. What lenders and investors look for
To have a good chance of securing funding, businesses typically need to show:
- A good financial track record (if it’s an existing business).
- Sound management.
- A business idea expressed in a well-researched, well-presented business plan.
- Financial controls and expert support.
- Personal commitment from its principal shareholders.
- Financial security.
A solid, well-established business, with steady sales and profits, and a good balance sheet, should have little difficulty in raising appropriate funding.
If your business has no track record, investors will look at the individuals running it. In particular, they will look for:
- Expertise in relevant areas.
- Good balance of skills.
- Proven ability to work effectively together.
Financial controls and expert support
Many potentially good businesses fail because they have cashflow problems and lack good financial controls. This makes investors wary.
Existing businesses looking for finance must have systems in place to address cashflow problems. But what can new businesses do to prove rigorous financial discipline?
- Show awareness of the issue in your business plan and in any interviews.
- Illustrate systems that will be put in place to address the issue.
- Get good financial advisers on board from the start.
Having an experienced accountant reassures investors. You can use him/her to:
- Check the forecasts and calculations in your business plan.
- Identify sources of income and expenditure you may not have considered.
- Advise on financial controls – records to keep, accounting software, the possibility of management accounting and occasional internal audits.
Always consider asking your bank too, which can offer a wealth of financial experience too.
Investors often look for you to have the confidence to put your own money into your business. This need not be a large percentage of the total capital, but enough to show that you are totally committed.
Security is a final fallback position, but investors must always consider the worst-case scenario. In the event of failure, they may look to get their money back from two sources:
- Selling any remaining assets in the business.
- Taking your personal assets.
The assets of a failed business may not amount to much. Employees and the taxman are paid before lenders, and lenders before shareholders, who may get little or nothing. The resale value of unused stock, plant and machinery is usually far below what you paid for them.
If the business is a limited company, with some legal exceptions, the shareholders’ liability is confined to the value of their shareholding.
So lenders may ask for some form of personal guarantee. This may be more as proof of your commitment than for its monetary value. Nevertheless, if your business is not a limited company, your personal assets – most significantly, your home – may then be used to pay off business debts.
More help on raising funding
ByteStart is packed with helpful guides and tips on all aspects of funding your business, including;
- Finding finance for your new business – funding advice for start-ups
- How peer-to-peer lending offers businesses a new funding option
- Crowdfunding – a new alternative for small and start-up businesses looking to raise money
- What are business angels and how they can help fund your business?
- Cashflow Forecasting – top tips to produce a better cash flow forecast
And for hints on planning and pitching, try these;