There are a number of different ways to finance a business – it’s all about finding the option that fits best with your company objectives and personal risk mindset.
Ultimately, you’re seeking finance to grow your business, and have decided that bootstrapping – using only existing resources to develop the business – is out of the question.
It goes without saying that there’s always a certain degree of risk with borrowing money, but it could enable your business to scale new heights and generate more profit.
Although traditional banks are still the predominant source of finance, smaller businesses are considering and using an increased range of finance options to meet their funding needs. We’ve rounded up some of the different ways to finance a business to help you make an informed choice about which route to take when you need to obtain business financing.
Bank Loan / Overdraft
A business loan remains the most popular source of finance among SMEs in the UK. Working in a similar way to a personal loan, to obtain a bank loan or an overdraft you must prove to the lender that the business will generate the income and cash to both repay the facility according to the terms of the loan, and service the loan by meeting interest payments.
The ease with which you can access a bank loan or an overdraft depends on a number of factors including market conditions and regulatory requirements, such as those that mandate responsible lending to viable business.
The latest figures, released by UK Finance, for Q3 2018 reveal that banks approved nearly 70,000 loans to SMEs in the final three months of last year and success rates “remain consistently high”, with eight out of 10 applications for finance being given the green light.
It’s likely that you’ll need to provide security for any money borrowed against other personal or business assets.
Invoice factoring – also known as debt factoring – is another way for businesses to generate the money they require to expand their operation.
Factoring, which can be provided by independent finance firms or banks, works by the business ‘selling’ their invoices to a third party at a discount, who agrees to manage the company’s sales ledger and credit control on an ongoing basis for a fixed period.
In return, the factoring company advances some funds upfront when the business client sends an invoice to a customer, which can be as much as 85% of the total invoice amount. This ensures that the business has a regular flow of cash by unlocking funds tied up in unpaid invoices
When the customer comes to pay their invoice, it’s the factoring company that collects the debt and makes the remaining balance available to the business client (you), minus their fees.
Using a Credit Card
Business credit cards are a quick and easy way to borrow money. Your ‘flexible friend’ can be issued to trusted staff, who are empowered to make funding decisions as they see fit.
The general principles of using a business credit card are the same as they are for a personal credit card: while they can be ideal if you need to borrow money to pay for day-to-day transactions and expenses, it’s not advised to be used for the large purchases which you might struggle to pay off quickly and therefore incur interest on the debt.
Because company credit cards are a type of unsecured lending, the criteria are fairly stringent and the limits are strict. As such, when applying for a business credit card, lenders will most likely look at your business credit score, and they may ask for personal guarantees to provide some security.
Debt crowdfunding is an alternative way for businesses to borrow money. It works largely in the same way as the traditional model of applying to a bank for a business loan, the main difference being that the finance is raised via a crowdfunding or peer-to-peer lending website, and the funds are contributed by multiple investors.
As part of the agreement, businesses are required to pay the investor(s) their money back with interest – but, crucially, they don’t have to sell any equity. It can be attractive to businesses seeking an alternative source of finance who have been unable to raise funds via banks or credit unions.
Depending on how much money is borrowed, you will typically be required to provide some security, in the form of business assets or a personal guarantee.
Take some time to assess the different ways to finance a business and ensure that you do your due diligence.
If you’re required to sign a personal guarantee to be able to borrow additional funds from a lender, you might want to consider personal guarantee insurance to moderate the risk.
Purbeck offers Personal Guarantee Insurance for SME Directors who have business loans or financial agreements. We cover up to 80% of your risk, giving you peace of mind as you plan the future growth of your business. Please contact one of our specialists today to learn more on 0208 004 7252.