Business Finance Options
Introduction
This section of the report covers the main sources of finance for a business,
considering the advantages and disadvantages of the options.
The section concludes with some advice on presenting a business proposition
to a lender or funding body.
Own Funds / Personal Borrowing
Using any savings that you may already have is often the initial consideration
when looking to fund a business. Even when looking at other options, there is
often a requirement for an element of your own monies being utilised.
If you're starting a new business, it's likely that you'll have to put up at least
half of the total money required yourself. It is usually difficult for a new
business to borrow from a bank if you are unable to provide any funds of your
own. However, any monies that you have already utilised in the business can
often be taken into account. Existing businesses, undertaking capital
expenditure, will, in all likelihood, have to contribute a percentage of their own
monies to any project. Overdraft facilities for existing businesses, to manage
cash flow, are often provided without such requirement.
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The easiest way to provide your own financing is to utilise savings. If not, then
consider;
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Raising funds against a property by, either increasing an existing
mortgage (a mortgage is essentially a loan secured against a
property), or by another lender providing finance against the property
(a second mortgage). Raising money in this way is often the cheapest
form of finance.
obtaining an unsecured personal loan, or borrowing on credit cards (
but see below)
raising funds by selling possessions or assets
You should think carefully before borrowing to finance your business and
should match the financing to your needs. For example, using credit cards for
long-term expenditure can be extremely expensive. Affordability is always the
key issue and be sure not to over commit yourself. You should also try to
leave a contingency fund, in case you need extra money to see you through a
difficult period.
Advantages
• Self-financing your business gives you far more control than other
finance options. Outside investors or lenders could decide to withdraw
their support at any time and they will expect a good return on their
investment in the form of interest, shares or dividends.
Disadvantages
• You need to be aware of the risks and the fact that you could lose your
savings, home and other personal possessions. Knowing how much
you have personally borrowed can put a lot of pressure on you and
your family.
Friends & Family
If you are unable to raise enough money to invest in your business yourself,
friends and family may be willing to help. They may simply lend money to you
or they might invest in your business, e.g. by buying shares in the case of a
Limited Company.
A business plan will help demonstrate how their money will be used and
ultimately repaid. It is desirable to have a written agreement in place, setting
out the terms and conditions, including the interest rate if applicable, and the
repayment terms. This should help avoid any misunderstandings particularly
as to when the money needs to be paid back by.
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Advantages
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Friends or family may be more willing to lend you money than a bank.
Friends and family may offer beneficial terms such as not charging
interest and providing flexible repayment schemes
If you can raise some finance from your own resources or friends and
family, then it is more likely that a bank or financer will also lend to your
business.
Disadvantages
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You need to think very carefully before borrowing from friends or
family. There is always a risk that they will lose their money and this
could put a significant strain on your relationship. Formal agreements
are seldom used and, in such instances, they may ask for the money
back earlier than you had anticipated which can again lead to conflict.
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It is wise for both sides to take solicitors / professional advice before
proceeding with any agreement.
Bank Lending
When seeking finance, an early discussion with your existing bank is a good
place to start. Whilst they will almost certainly require a business plan, have a
talk with them to outline your plans first. There is no point putting a lot of effort
into a detailed plan if the banks lending criteria (for example, your own
contribution level) cannot be met. An early discussion with a bank(s) should
tell you if you have a proposition which they can consider. They will then ask
you to provide a detailed business plan.
Overdrafts and bank loans are the most common sources of bank finance;
Bank Loans
A loan is an amount of money borrowed for a set period, within an agreed
repayment schedule. The repayment amount will depend on the size and
duration of the loan and the rate of interest.
Loans are generally most suitable for:
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paying for assets - e.g. vehicles
start-up capital
capital expenditure – eg property improvements
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The terms and price of loans will vary between providers and will reflect the
risk and cost to the bank in providing the finance. For larger sums, the pricing
and terms may be negotiable.
Banks will need to understand your business and its ability to repay the loan.
A detailed business plan should enable the bank to understand your business
and its ability to repay the loan. Your plan needs to provide a clear
explanation of your business, how the money will be used, together with a
detailed cash flow and profit forecast.
Loans can be geared to the lifetime of the equipment or other assets you're
borrowing the money to pay for.
At the beginning of the term of the loan, you may be able to negotiate
a repayment holiday, meaning that you only pay interest for a certain amount
of time, while repayments on the capital are frozen.
Interest rates may be fixed or variable. If you can negotiate a fixed rate you
will know that your repayments will not change during the fixed interest rate
period – this could be the whole term of the loan.
Arrangement fees usually apply to loans, being a percentage of the loan
amount.
Disadvantages of loans
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Larger loans will have certain terms and conditions that you must
adhere to, such as the provision of quarterly financial information.
You may have trouble meeting your monthly repayments if your
customers don't pay you promptly, causing cashflow problems. In such
instances, keep the bank informed.
In some cases, loans are secured against the assets of the business or
your personal possessions, e.g. your home. Security is usually required
for loans over £20,000.
Your assets or home could be at risk if you cannot make the
repayments.
There may be a charge if you want to repay the loan before the end of
the loan term, particularly if the interest rate on the loan is fixed.
If you don't meet the bank's normal requirements, you may qualify for a loan
under the Enterprise Finance Guarantee scheme – details of this scheme are
detailed under a separate heading.
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Bank Overdrafts
An overdraft is simply an agreement with the bank, allowing you to “overdraw”
your account up to an agreed limit. The facility will be in place for a period of
time, usually one year, after which renewal can be negotiated. Overdrafts are
used to manage cashflow, hence the bank may require a forecast of your
anticipated cashflow. It is only by producing such a forecast that the actual
level of the overdraft can be determined. This document should predict the
flows of money in and out of your bank account, highlighting any months
when you may need to “overdraw” your account – this is typically when you
incur day to day expenditure, ahead of receiving monies from customers.
An overdraft should not be used for capital expenditure as this is best served
by way of a loan.
Advantages of an overdraft
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An overdraft is flexible - you only borrow what you need at the time
which may make it cheaper than a loan.
It can be quick to arrange.
Interest charges are only incurred on the days when you use the
facility.
There is not normally a charge for paying off the overdraft earlier than
expected.
Disadvantages of an overdraft
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Arrangement fees are payable, with an additional fee if the facility is
increased.
Your bank could charge you a penalty fee if you exceed your agreed
limit without authorisation.
The bank has the right to ask for repayment of your overdraft amount
at any time, although this is unlikely to happen unless you get into
financial difficulties.
Overdrafts may be secured against business assets.
Unlike loans you can only get an overdraft from the bank where you
maintain your current account. In order to get an overdraft elsewhere
you would need to transfer your business bank account.
The interest rate applied is nearly always variable, making it difficult to
accurately calculate your interest costs.
Unutilised overdraft facilities may be reduced by the banks at short
notice, although this is unlikely to happen unless you get into financial
difficulties.
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Bank Lending – Enterprise Finance Guarantee
For normal loans over £20,000, banks will usually require some form of
security, usually in the form of a legal charge (mortgage) over a property. This
means that, should you be unable to repay the loan, then bank could force a
sale of the asset to repay the loan.
There may be instances where the bank is happy with the business plan and
the viability of the business, but, because of the size of the loan, require some
form of security. In the absence of security the bank may be unwilling to lend.
The Enterprise Finance Guarantee (EFG) is a government backed loan
guarantee scheme intended to facilitate additional bank lending to viable
businesses who do not have sufficient, or no, security with which to secure a
loan.
EFG is a scheme used by lenders on a discretionary basis. It is also not a
scheme through which businesses or their owners can choose to withhold
security a lender would normal lend against; nor is it intended to facilitate
lending to businesses which are not viable. It is simply a scheme which gives
the bank a level of security which would not otherwise be available. The
ongoing viability of the businesses is still of key importance and any
businesses utilising the scheme would need to produce a quality business
plan, demonstrating such viability
The scheme provides lenders with a Government backed guarantee for 75%
of the loan value, facilitating lending that would otherwise not be
available. EFG is intended to support lending to businesses that can
ultimately repay the loan in full, and is a guarantee to the lender, not
insurance for the borrower in case of default.
The Government charges the borrower a fee which partially covers the cost of
the guarantee. This premium is equivalent to two per cent per annum on the
outstanding balance of the loan, and is assessed and collected quarterly
throughout the life of the loan. However, it is not an insurance premium. The
interest rates and any other fees and charges made by a lender are a
commercial matter for the lender concerned.
EFG Eligibility Criteria
EFG supports lending to viable businesses with an annual turnover of up to
£25m seeking loans of between £1,000 and £1million. It is available to
businesses in most business sectors.
However, EFG is subject to certain sector restrictions. A list of the main
sector restrictions is provided in the EFG Business Sectors website
www.bis.gov.uk. EFG is used by a lender when addressing the debt finance
requirements of viable businesses which, although they do not have sufficient
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security, can demonstrate to the lender that they have capacity to ultimately
repay the loan in full.
Leasing
Leasing is a contract between the funder (lessor) and a customer (lessee),
giving the customer the use of the item of equipment, in return for payment of
rentals over an agreed period. The lessor retains ownership of the asset,
which means that the customer pays to use the equipment over a set period
of time - typically the agreed working life of the equipment.
There are different kinds of lease arrangements. It makes sense to consider
them all to see which is best suited to your business, your particular
circumstances and the asset that you are acquiring. In case of doubt,
professional accountancy advice should be taken.
The three main types of leasing are finance leasing, operating leasing and
contract hire.
Finance leasing
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A long-term lease over the expected life of the equipment, usually
three years or more, after which you pay a nominal rent or can sell or
scrap the equipment.
The leasing company recovers the full cost of the equipment, plus
charges, over the period of the lease.
Although you don't own the equipment, you are responsible
for maintaining and insuring it.
You must show the leased asset on your balance sheet as a capital
item, or an item that has been bought by the company.
Leases of over seven years, and in some cases over five years, are
known as 'long-funding leases' under which you can claim capital
allowances as if you had bought the asset outright.
Monthly payments can be matched to your cash flow. At the end of this
commercial leasing agreement, the relevant assets are sold and you
receive the major share of the proceeds. As the asset owner, the
lessor claims the available writing-down tax allowances and reflect this
in your monthly payments.
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Operating leasing
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Fixed costs - for a set sum you can use the asset immediately
Cash flow boost - a residual value is fixed that lowers your payments
Flexible repayments - rentals can be tailored to match your seasonal
cash flow
Fixed or variable interest options - you decide which suits you best
Off-balance sheet - check with your auditor about this business
advantage
Tax efficiencies - VAT is reclaimable on the rentals, while payments
can normally be offset against taxable profit (special rules apply to
cars)
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Contract hire
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Often used for company vehicles.
The leasing company takes some responsibility for management and
maintenance, such as repairs and servicing.
You don't have to show the asset on your balance sheet.
You don't have to pay the full cost of the asset up front, so you don't
use up your cash or have to borrow money
You have access to a higher standard of equipment, which might be
too expensive for you to buy outright
You pay for the asset over the fixed period of time that you use it,
which helps you to budget for the future
As interest rates on monthly rental costs are usually fixed, it is easier
for your business to forecast
You can spread the cost over a longer period of time and match
payments to your income
The business can usually deduct the full cost of lease rentals from
taxable income
If you have not bought the asset outright, you won't have to worry
about any overdraft or other loan taken out to finance the purchase
being withdrawn at short notice, forcing early repayment
If you use an operating lease or contract hire, you may not have to
worry about maintenance
The leasing company carries the risks if the equipment breaks down
The leasing company can usually get better deals on price than a small
business could and will have superior product knowledge
On long-funding leases - finance leases over seven years and
sometimes over five years; and some long operating leases - you can
claim capital allowances on the cost of the assets
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If you need to upgrade or replace the equipment, you can simply make
a small adjustment to your regular payment rather than invest a lump
sum upfront
Some disadvantages of leasing or renting equipment:
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You cannot claim capital allowances on the leased assets if the lease
period is for less than five years (and in some cases less than seven
years)
You may have to put down a deposit or make some payments in
advance
It can work out to be more expensive than if you buy the assets
outright
Your business can be locked into inflexible medium or long-term
agreements, which may be difficult to terminate
Leasing agreements can be more complex to manage than buying
outright and may add to your administration
When you lease an asset, you don't own it, although you may be
allowed to buy it at the end of the agreement
Small Loans for Business – CDFI’s
If your business is setting up in a deprived area, or in a sector that is not
normally catered for by mainstream lenders, you might be able to attract
finance from a Community Development Finance Institution.
If your business is setting up in a disadvantaged area or a sector that is
typically underserved by mainstream lenders, you may be able to secure
finance or support from one of the alternative sources of micro finance. These
include community development finance institutions (CDFI’s).
CDFI’s are sustainable, independent organisations established to develop and
create wealth in disadvantaged communities or markets. They provide capital
and support to individuals, micro enterprises and small businesses.
A loan from a CDFI can be used to purchase equipment or property, to
finance working or start-up capital or to fund marketing campaigns. Loans can
be for as little as £50 or up to £1 million depending on the project.
www.findingfinance.org.uk
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Grants and government support
Your business may qualify for a grant or government support to help you get
started.
The main advantage of grants is that, whilst there may be strict guidance as to
the use of the funds, the money does not have to be repaid. Alternatively, if
funds are provided by the way of a loan, you might get a subsidised or zerointerest loan. In addition, support schemes can provide expert advice,
information or subsidised consultancy.
However there are drawbacks:
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there is strong competition for grant schemes - you may spend a lot of
time on an application which is not successful
you must meet the scheme's criteria - such as business location and
size, and how you plan to use the money
the application procedure can be complex and drawn out
you normally have to use the grant for a specific project, rather than
general business costs
grants usually only cover a percentage of the costs - you also have to
provide matching funds
http://www.nnbf.co.uk/
http://www.northnorfolk.org/business.asp
Princes Trust
The Enterprise Programme is for people who:
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Have a business idea they want help to explore
Are aged 18-30
Are unemployed or working less than 16 hours a week
Live in England, Wales, or Northern Ireland
www.princes-trust.org.uk
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Prime
PRIME is a member of the Community Finance Development Association
(CDFA), and offers loans on a non-profit basis to people over 50 seeking
funds to become self-employed / set up their own business. Applicants must
have been turned down by the regular High Street banks and also meet the
scheme’s other strict eligibility criteria.
The PRIME Business Start-Up Loan offers between £500 and £10,000. It is
only available to those with a strong viable business proposition.
Business Angels
A business with good prospects might attract outside investors. For example,
'business angels' typically invest £10,000 or more in exchange for a share in
the business.
Typically, your company issues ordinary shares (standard shares with no
special rights or restrictions) to investors in return for their capital.
Outside investment can suit promising businesses that do not expect to
produce a lot of spare cash in the short term but offer the potential of greater
returns over the longer term.
Business angels are wealthy individuals who typically invest £10,000 upwards
and who may also offer business expertise. Venture capitalists usually invest
more than £2 million in businesses where they believe they will receive a high
return on their investment by exiting (selling their investment) at a certain
time.
Before approaching potential investors you need a good business plan,
including evidence of your management ability. Your plan should include
detailed financial forecasts and demonstrate what you will do with funds
invested in the business. You will also need to prepare a pitch, which will sell
your business to potential investors.
http://www.bbaa.org.uk/
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Advantages
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Attractive for businesses looking to bring in additional expertise as well
as funding.
Unlike loans and overdrafts, you do not normally have to make
payments to investors until the business can afford them.
Increasing the capital invested in the business makes it easier to
borrow from the bank.
Disadvantages
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Your share of the business, and of its profits, will be lower.
Investors may want control over how you manage the business.
Investors may want the business structured in a way that makes it
easier to sell their shares in the future.
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Presenting your case to a Bank / Funding body
This section provides advice on giving you the best chance of securing
finance for your business
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Undertake early discussions with bank / funding body to determine if
your application meets any criteria “in principle”. You should do this
before producing any formal plan. Seek repayment quotes from any
proposed lender.
Produce a detailed business plan – Business Link can provide
templates and guidance on how to do this. If you are unsure ask for
help.
The Business plan will help you assess if the funding is required, how
much is required and if the proposition is viable. Remember, if you are
unable to convince yourself then you have little chance in persuading
anyone else.
The Plan should include a detailed explanation of how your Business
operates on a day to day basis – it is essential that this is clear to the
Bank / provider. Even the most viable business will have difficulty
raising finance if the lender does not understand the operation. Include
images where possible. Invite lenders to your business at an early
stage if this helps the understanding process.
Be very clear as to how much is required and exactly what the monies
are needed for. Many plans fail to give sufficient detail.
Include examples of quality marketing material / press articles / screen
prints of web sites.
The finance section will need to be able to withstand vigorous
checking. Make sure you can explain the numbers yourself, even if you
have had some help in their production / presentation. This section
should include sales forecasts / cash flows and a profit and loss
account. This numbers must be realistic and demonstrate that your
business is viable.
Make sure the repayment plan, in respect of a loan, is clearly shown
and included in the viability assessment.
Present hardcopies of your plan in a professional folder – presentation
does matter and it is worth spending a little extra on a quality binder for
any hardcopy. Electronic versions should be available and must
convey the same level of professionalism.
The bank will consider past credit history (including personal
information provided by Credit reference agencies) and you should be
ready to answer any questions relating to this. If you do have adverse
credit information against you, tell the lender at the outset.
It is very important that you consider, yourself, whether you can afford
the borrowing. If you are confident then this will be reflected during any
discussions you have with the bank. However, remember to be realistic
at all times. Any forecasts that you make will need to be substantiated.
If your lender requires security they will recommend that you get
independent advice
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