The financing requirements of businesses vary. It depends on need and an awareness of what’s available. The 10 most popular ways to finance a business centre on an increasing number of products on the market and a rising awareness among the business community of what is available.
The most popular business finance types are:
- Bank loans
- Overdrafts
- Business mortgages
- Invoice financing
- Peer-to-peer lending
- Leasing and hire purchase
- Crowdfunding
- Angel investment
- Private equity
You can split these into three broad areas:
- High street and challenger bank lending
- Equity finance
- Asset-based lending
According to research by the British Business Bank, awareness of finance options outside of traditional lending grew in 2018 with 52% of smaller businesses aware of P2P, 70% are aware of crowdfunding platforms and 69% said they were aware of venture capital, up from 2017 figures of 47%, 60% and 62% respectively.
It’s not just about awareness. Different funding options are popular in different areas of the UK. Equity finance and angel finance tend to be concentrated in London while more debt-based finance options find favour elsewhere in the country
Bank loans
Access to finance is an important issue for SMEs and remains high on government agendas. If you are considered a low to medium risk your business should have little difficulty in accessing this type of finance.
The proliferation of new ‘challenger’ banks – banks other than the top 5 UK high street banks – is providing greater choice for businesses and some of them provide an option if you are finding it difficult to access more traditional funding. This is because challenger banks are more willing to take on higher risk borrowers.
There are various types of business loans and which one you choose depends on your situation. Contact one of our experts for more information.
Overdrafts
According to the British Business Bank fewer businesses are relying on overdrafts. The value of outstanding overdrafts for both small and medium-sized businesses has declined by 30% since 2011. However, overdrafts remain a viable debt option for short-term loans, where a quick injection of cash is needed.
Business mortgages
Business mortgages are your best option of you are looking to purchase property for your business. They are based on complex pricing models and the verdict of lending panels at each individual lender. In addition to valuation, arrangement and legal fees, there are often other associated costs that you need to consider.
Lender fees are typically around 1% and most small or medium-sized loans offer an LTV of 75%, sometimes up to 80% over a standard term of 15 years, but this can be up to a maximum of 25 years.
Invoice financing
The UK is the largest global invoice financing market – slightly ahead of China. According to some estimates there are around 60 active invoice finance and asset-based lending providers of a significant size in the UK. The most recent data reveals that there are 38,357 SMEs using invoice finance facilities.
Cheaper than getting an overdraft, invoice financing is a great short-term fix if you have cashflow issues and a business to business aged debtor ledger.
There are two types of invoice financing. Factoring and discounting both work on the basis of releasing funds that are held in your unpaid invoices. You effectively raise finance against debt owed to you. The difference lies simply in who takes control of your sales ledger, and importantly the responsibility for collecting outstanding payments.
With Factoring, the finance provider takes the control and payments are made direct to them. Invoice discounting, however, allows you retain control as well as an element of confidentiality; your customers will not be aware that you have a third-party finance company involved because all payments and communications will be direct with you.
Peer-to-peer lending
The British Business Bank reports that the awareness of Peer-to-peer (P2P) lending continues to grow. Although highly regulated, the UK market is the third largest globally.
Peer-to-peer finance brings together individuals or businesses seeking to lend money to businesses who are looking to borrow money without going through a bank. A good example of a P2P lending platform is Funding Circle.
On some sites, lenders can choose which borrowers they want to lend to. On others the money invested via the site is split automatically between a number of borrowers.
P2P lending is a good solution if you’re looking for a loan over a fixed period of time, compared with a conventional business loan as it is quicker. Even better if your company is in a strong cashflow position and has assets to secure against the finance. Asset-backed debt will always help to keep the interest rate lower and a good cash flow reassures investors that late payments are unlikely.
Leasing and hire purchase
If you need to invest in equipment or machinery you can spread the cost by leasing or hire purchase. Doing so helps you to buy what you need with a reduced cashflow impact. There are two types of assets – hard assets (equipment and machinery) and soft assets (software, services and the like).
Once you have identified the equipment you want you can either rent the asset back over a fixed period in return for regular payments, but do not get ownership (leasing) or take out a hire purchase agreement; in which case, once all agreed payments have been made, ownership of the equipment transfers to the business.
In a finance leasing arrangement, the asset can continue to be rented or it may be possible to make a final payment to own it.
For more information on leasing and hire purchase visit our website.
Crowdfunding
With crowdfunding people invest in exchange for an equity share in your business, with the risk that their share value may fluctuate as the business grows.
Managed via online platforms, crowdfunding allows you to pitch your business in search of willing investors via online platforms. By attracting a crowd of people, each with a small stake, you’ll benefit from valuable finance.
There are lots of crowdfunding sites out there and the rules will differ from one to the next. The general plan is that you pitch your business idea on your chosen site and set a fundraising goal for the total amount you’re looking to raise. You’ll need to set a deadline too, because if the total required is not raised, the funding won’t go ahead. Click here for more on crowdfunding.
Either way, the value held in your invoices act as the debt security, so both are a viable short-term funding solution.
Angel investment
An important source of finance for SMEs, business angels are high net worth individuals who provide financing to small businesses in exchange for an equity stake in the business. Business angels may also provide expertise in helping to run the business.
SME awareness of external finance from business angels varies across areas. If a business isn’t aware of possible finance options, they won’t apply for them and it leads to finance getting concentrated in certain places. A British Business Bank Finance Survey found that 47% of SMEs in London were aware of angel investment, while areas such as the North or Midlands had awareness rates of 39% and 35% respectively. So, the supply of equity finance from business angels is under-represented in areas outside London.
If you have a great business idea which is just getting it off the ground, and you need finance to move it to the next level, you could consider angel investment. It’s a great way to achieve business lift off at an early stage.
Before you start looking for Angel investment you will need to put together a first-rate business plan and a financial model for the next three years of your trading which include monthly cashflow and profit and loss and balance sheet details. Off the back of this you will also need to provide a pitch deck.
Private equity
Private equity investors buy companies and business assets in order to sell them on for a profit.
Private equity firms gather a fund of money and invest in underperforming businesses with a view to turning them around and exiting with a positive gain, or high growth businesses. Investors generally assume a non-executive interest in the business to help shape the future direction. Equity finance is only useful to you if you are happy for third parties to have a stake in your business.
Private equity investors will take a very hands-on approach to being involved in the day-to-day running of your business, often making significant changes from the outset. They will provide financial, strategic and operational input as required in order to steer the business to an enviable position and will typically look to exit the business between 3 and 7 years.