Small business funding – what are the main sources of finance?

Most small businesses will, at some stage, seek funding or investment – for growth, starting up, or to see them through a transitional period (or a downturn). In this article, we look at the main sources of funding that are available.

The best ways to fund your new business venture

When you first start out on your own, it is often hard to plan too far in advance. Your predicted cash burn may well increase, or you may be pleasantly surprised by how quickly the venture gets off the ground, and you don’t need to provide as much finance as you initially thought.

Even if you only use a business plan as a rough guide, you really should spend some time working out different scenarios, ‘what ifs’, so that you always have some wriggle room in case things don’t work out quite as you imagined, at least, not at the start.

Most people overestimate revenue and underestimate costs, so take account of that. And think how late payers and seasonal effects could put extra pressure on your cash flow.

Try our essential guide – 10 things to consider before starting a new business – for more useful advice.

With this in mind, let’s look at the main ways small business people raise money:

Personal Sources

A large number of start-ups are ‘self-funded’ – either via savings, loans from family and friends, or via existing sources of personal borrowings. Sometimes it can be difficult to raise funds from other sources if your business plan or case is not easily understood by third parties, so personal funding is often the only realistic source of initial funds.

Many small businesses are started using personal debt raised by the owners. Unsecured loans give you the advantage of fixed repayments over a certain period of time, helping your financial planning.

Banks and Finance Companies

By far the most common source of funding comes from high street banks – in the form of loans, overdrafts, and other types of finance.

You may find it significantly cheaper to borrow more money on your mortgage, than taking out a personal loan, but you will have debt secured on your home, which increases the risk you take.

You could also use overdrafts or credit cards, although these are expensive and unreliable ways to borrow money in the long-term. If you do manage to secure commercial funding, it’s possible the bank will demand your house or other property as equity.

Banks and more specialised finance companies also offer more ‘alternative’ sources of credit, such as factoring and invoice finance (which free up the value of your invoices, for a fee).

Business Angels / Investors

If you would like to bring in funding from an outside investor, you will typically seek out business angels who look for interesting projects to invest in and make money from. These are usually wealthy individuals, who have previously sold a successful business.

Securing this type of investment will require some serious effort on your part.  You need a sound business idea, a solid business plan, and provide a real opportunity for fast growth. Then you need to find potential investors and pitch to them.

There are two main types of equity investors. Venture Capitalists are typically large firms that put in £1 million or more.

Business angels are private investors who will offer smaller investments, from a few thousand pounds upwards. Sometimes several angels will club together.

For the investors, the risks are high, so they expect a good return on their investment. Also, as it will be partly their money you’re working with, it’s likely they will want to be involved with the strategic decisions you make in your business.

Unlike banks, outside investors will provide funds in return for a share in the business. They may also provide expertise to your business, which can prove as valuable as a cash injection in some cases.

Factoring (Invoice Finance)

This is where you sell your debt to another company. It’s normally used by businesses that must offer credit terms on invoices, but don’t want to wait 30, 60, or 90 days to be paid.

The factoring company pays you immediately and collects the money from your customer when it’s due.

The factoring company will charge you a fee and a percentage of the value of each invoice. It might stop you needing to borrow a lump sum just to keep your cash flow healthy. Read our guide to factoring and invoice finance for further details.

Grants

Other sources of funding include grants (both Government and private sector) – there are thousands of grants available depending on your industry and location.

Several organisations may give you a lump of cash you won’t have to repay. Your eligibility normally depends on you, where your business is based and what it does.

The Prince’s Trust offers some grants in exceptional circumstances. Other grants are available from the government, EU, regional development agencies, and some charities.

Remember to get professional advice from a qualified accountant before taking any action. Don’t rely purely on information contained in this article.

Last updated: 4th May, 2021

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