If you are looking to start a new business, there is a good chance that you will need some funding to get it off the ground.
Most businesses will have start-up costs, whether it’s securing premises, stock, equipment or hiring people, and they will all need paying for, so what options are there to fund a new business?
Some people might have savings, or a redundancy payment, they can use to fund their start-up, but others will need to find funds before they can launch their new business. However, as many prospective business owners find out, getting start-up finance can be difficult.
For someone who just wants to start their own business, negotiating the finance maze can be confusing and take up a lot of valuable time. To help increase your chances of success, here are the answers to some common questions on how to fund a new business;
Q1. What financing options do start-up businesses have – and how do you decide which is right for you?
It is essential to decide what is the most appropriate form of finance required. This will depend on your type of business and what the finance is required to fund. Let’s look at a few examples;
Medium term loan or hire purchase
If, for example, a construction company needs to buy new equipment then a medium term loan or hire purchase could be suitable (hire purchase involves monthly payments to lease equipment, the equipment is “owned” once the full amount of the contract is paid) as this will allow the cost/payments for the new piece of equipment to be spread over a period of time.
Our Guide to Choosing the Right Business Loan tells you more about finding the right loan for your business.
Overdraft and/or invoice discounting
If, for example, a fashion retailer needs to fund the buying of stock then an overdraft could be a solution.
Invoice discounting and factoring might also be suitable. Invoice discounting is aimed at larger businesses where unpaid sales invoices are used as collateral, whilst factoring involves selling your “future sales” invoices to a third party which collects the full amount paying over a proportion to the business).
An overdraft would provide immediate funds and/or allow scope for future funds to be used for the growth of the business whilst invoice factoring/discounting will allow the business to spread the cost of the funding over time based on the future sales of the stock.
If developing a building project – then project finance that can be drawn down at key stages should be considered as this will provide necessary funds at the specific times when it is required.
If under-capitalised – a medium term investor would be more acceptable and will provide a more sustainable way of obtaining funds than, say, short term credit solutions.
Crowdfunding is an increasingly popular way of raising finance. It can take two forms; equity crowdfunding and rewards-based crowdfunding.
Equity crowdfunding is essentially a sale of shares in the company, whilst rewards-based crowdfunding offers ‘perks’ in return for money (in other words the person doesn’t invest in the company, they ‘buy’ something). For example, if it’s a new piece of tech the funders may get the very first product, before its on general release, or they may get a personalised version of the product.
Peer to Peer lending
Peer to Peer, or P2P lending as it’s frequently referred to, is another option. Here, you essentially borrow money from a group of other individuals.
P2P lending has grown rapidly over recent years as businesses have grown frustrated with the reluctance of banks to lend, and savers have become disillusioned with rock-bottom interest rates.
Credit cards and payday loans
Some entrepreneurs fund a new business with credit cards or online payday loans. These options can offer a quicker way to access finance but aren’t the best way to borrow money for the longer term as interest rates will be higher.
Q2. Lenders often like to see a ‘track record’ but as a start-up I don’t have one – so what can I do to give investors similar comfort?
For businesses with a track record it is always advised that accounts should be used as a sales document, for example abbreviated accounts do not explain how you’ve operated and future plans (they’re not a sales document), whilst full accounts are a more suitable sales document.
Clearly this is something to bear in mind in the future but it is not helpful to start ups that will not have accounts to present to the potential investor (in the case of limited companies or limited liability partnerships it can often be a year before they are ready to prepare accounts and for sole traders and partnerships they won’t be required to prepare accounts until 5 April).
Therefore as a minimum start-ups should have cash flow forecasts which are backed up with evidence as to why the forecast has been made.
You will also need a detailed business plan as this provides an opportunity to “sell” your business. It should include:
- What the business does
- Who owns the business, what are their expectations
- Who runs the business, what is their experience
- Who are your main competitors ( why are you better/how will you become better)
- What are your historical results
- What are your projected results (business plans gives more scope for outlining this than a set of accounts)
- How are you going to achieve the results
Online tools such as Brixx can save a lot of time and effort when it comes to producing cash flow forecasts and a professional business plan so are worth using.
Q3. What information is essential to provide when seeking finance, and how do I improve my chances of getting funding?
As noted above cash flow forecasts and a detailed business plan are essential when seeking finance. It is important to “sell” your business and provide as much information as possible.
As a general rule always consider what your potential finance providers will need to understand, such as:
- What’s the money for and what are the potential benefits?
- Are the interest and capital payments affordable?
- What security is available?
- What are other sources of finance?
- How will the finance provider get their money back? (perhaps by way of a loan bearing interest and security over an asset); or
- How will an investor get a return on their investment (perhaps by way of issuing them preferential shares).
Q4. Where can I go for help?
It is always a good idea to consult your accountant as they will be able to advise on the different finance options available, as outlined above, and which would be the most appropriate option for your business. They will also be able to advise on the accountancy and tax consequences of each option.
Accountants often have links with business angels networks. These are usually groups of private investors who individually invest smaller amounts (usually around £100k) in a small, private business.
Just like the Dragons in the Den these individuals are looking to get as big a slice of the company as possible for their money. Ask your accountant for advice – they will know the network and if it is suitable for your business.
Lawyers can also be consulted when looking to finalise a finance option particularly if agreements are required to be drawn up between the investor and the business, it is essential that any agreement is formalised in order to protect all parties.
Financial institutions will always ensure sufficient agreements are drawn up but it is just as important for these agreements to be prepared for any investor/finance provider even if they are friends and family.
Whatever finance option you choose it is best to get professional advice – choosing the right finance route and agreeing the right deal are both essential elements if you want to protect the future of your business. Get it wrong and your business will suffer – and may even die.
Last updated - 10th February, 2017