Business finance explained

Overview

The most suitable finance option for your business depends on many things, including:

• how much funding you need
• your current business revenue or if you’re a new business
• whether or not you’re willing to offer personal assets as security – this can make it easier to get funding but is risky if you’re not able to maintain payments
• whether or not you own a business property – this can make it easier to get funding
• whether or not you’re willing to sell shares

This guide explains the different types of funding available.

Find funding

Find out more about business finance options or search for finance schemes in your area for your type of business.

The business finance and support finder has a list of public funding (eg government schemes) available in the UK.

Investment finance

Investment finance (also known as equity finance) involves selling part of your business (‘shares’) to an investor. The investor will take a share of any profits or losses that the company makes.

Advantages

Advantages include:

• investors can bring new skills and opportunities to the business, eg marketing or exporting overseas
• you won’t have to pay any interest, or repay a loan
• you share the risks of the business with your investors

Disadvantages

Disadvantages include:

• it can be a demanding, expensive and time-consuming process
• you’ll own a smaller share of your business (although your share could eventually be worth more money if your business succeeds)
• you may have to consult your investors before making certain management decisions
• only limited companies can sell shares, so you can’t raise money in this way if you’re a sole trader or in a partnership

Tax relief to investors

Some government schemes help companies raise investment finance by offering tax relief to investors:

• Seed Enterprise Investment Scheme
• Enterprise Investment Scheme
• Venture Capital Trust Scheme

Find funding

You can look for either:

• private finance providers (eg banks)
• public funding (eg government schemes)

Crowdfunding

Crowdfunding (also known as crowd financing or crowd-sourced capital) involves a number of people each investing, lending or contributing smaller amounts of money to your business or idea. This money will then be pooled to reach your funding target.

Your idea will usually be showcased through a crowdfunding website.

Advantages

Advantages of crowdfunding include:

• it provides an alternative to funding from conventional means, eg bank loan
• you can raise finance relatively quickly, often without upfront fees
• it can raise awareness of your new business

Disadvantages

Disadvantages of crowdfunding include:

• your idea could be copied if you haven’t protected it with a patent or copyright
• any money you raise will normally be returned to investors or contributors if you don’t reach your funding target
• crowdfunding is mostly unregulated (but from 1 April 2014, loan-based and investment-based crowdfunding will be regulated by the Financial Conduct Authority)

Find funding

You can look for either:

• private finance providers (eg banks)
• public funding (eg government schemes)

Loans

A loan is credit, usually in the form of cash, that you borrow and repay over an agreed length of time. Banks, community development finance institutions, other businesses and even friends and family can provide businesses with loans.

As well as repaying the amount you’ve borrowed, you normally have to pay interest on a loan. The amount will depend on:

• how long you need the loan for
• how much you borrow
• whether the loan is ‘secured’ - eg if you own your home and agree to transfer ownership to the loan provider if you don’t keep up your payments
• other factors, like the Bank of England base rate

The interest rate may be:

• fixed, so it won’t change for the length of the loan
• variable, so it will change with the Bank of England base rate or the bank’s cost of borrowing

Reasons for getting a loan

Loans are generally suitable for:

• paying for assets - eg vehicles or computers
• start-up capital
• instances where the amount of money you need won’t change

Advantages

Advantages include:

• unlike overdrafts, loans are not repayable on demand - this means that you’re guaranteed the money for the whole term (generally 3 to 10 years)
• loans can be tied to the lifetime of equipment or other assets you’re borrowing the money to pay for
• you won’t have to give the lender a percentage of your profits or a share in your company

Disadvantages

Disadvantages include:

• loans aren’t very flexible - eg you may have to pay charges if you repay early
• you might struggle to meet monthly payments if your customers don’t pay you
• if your loan is secured against your personal property or assets (eg your home) you could lose them if you don’t keep up the payments
• the cost of repayments for variable rate loans can change, making it harder to plan your finances

Find funding

You can look for either:

• private finance providers (eg banks)
• public funding (eg government schemes)

Grants

A grant is an amount of money given to an individual or business for a specific project or purpose.

You can apply for a grant from the government, the European Union, local councils and charities.

You won’t need to pay a grant back, but there’s a lot of competition and they are almost always awarded for a specific purpose or project.

Advantages

Advantages include:

• you won’t have to pay a grant back or pay interest on it
• you won’t lose any control over your business

Disadvantages

Disadvantages include:

• you’ll have to find a grant that suits your specific project, which can be difficult
• there’s a lot of competition for grants
• you’ll usually be expected to match the funds you’re awarded, eg a grant might cover part of the cost of a project but you’ll have to fund some of it yourself
• grants are usually awarded for proposed projects, not ones that have already started
• the application process can be time-consuming

Find funding

You can look for either:

• private finance providers (eg banks)
• public funding (eg government schemes)

Overdrafts

An overdraft is a credit facility you agree with your bank. It allows you to temporarily spend more than you have in your account to cover short-term financing needs.

It should not be used as a long-term source of finance - if an overdraft is used persistently your bank may question whether you are in financial difficulty.

You’ll need to agree your overdraft limit with your bank. You’ll usually be charged interest on any money you use, and may also have to pay a fee.

Advantages

Advantages include:

• it’s flexible - you only borrow what you need at the time, making it cheaper than a loan
• it’s quick to arrange
• you normally won’t be charged for paying off your overdraft earlier than expected

Disadvantages

Disadvantages include:

• there will usually be a charge if you want to extend your overdraft
• you could be charged if you go over your overdraft limit
• the bank can ask for the money back at any time
• you can only get an overdraft from the bank that you hold your business current account with

Find funding

You can look for either:

• private finance providers (eg banks)
• public funding (eg government schemes)

Invoice financing

Invoice financing is where a third party agrees to buy your unpaid invoices for a fee. Invoice financiers can be independent, or part of a bank or financial institution.

There are 2 types of invoice financing in the UK.

Factoring

‘Factoring’ - also known as ‘debt factoring’ - usually involves an invoice financier managing your sales ledger and collecting money owed by your customers themselves. This means your customers will know you’re using invoice finance.

1. When you raise an invoice, the invoice financier will buy the debt owed to you by your customer.

2. They make a percentage of the cost (usually around 85%) available to you upfront.

3. They then collect the full amount directly from your customer.

4. Once they’ve received the money from your customer, they make the remaining balance available to you.

5. You’ll have to pay them a discount charge (interest) and fees - the amount depends on which invoice financier you use.

Invoice discounting

With ‘invoice discounting’, the invoice financier won’t manage your sales ledger or collect debts on your behalf. Instead, they lend you money against your unpaid invoices - this is usually an agreed percentage of their total value. You’ll have to pay them a fee.

As your customers pay their invoices, the money goes to the invoice financier. This reduces the amount you owe, which means you can then borrow more money on invoices from new sales up to the percentage you originally agreed.

You’ll still be responsible for collecting debts if you use invoice discounting, but it can be arranged confidentially so your customers won’t find out.

Advantages

Both kinds of invoice financing can provide a large and quick boost to your cash flow.

Advantages of factoring include:

• the invoice financier will look after your sales ledger, freeing up your time to manage your business
• they credit check potential customers meaning you are likely to trade with customers that pay on time
• they can help you to negotiate better terms with your suppliers

Advantages of invoice discounting include:

• it can be arranged confidentially, so your customers won’t know that you’re borrowing against their invoices
• it lets you maintain closer relationships with your customers, because you’re still managing their accounts

Disadvantages

Some disadvantages of invoice financing are that:

• you’ll lose profit from orders or services that you provide
• invoice financiers will usually only buy commercial invoices - if you sell to the public you might not be eligible
• it may affect your ability to get other funding, as you won’t have ‘book debts’ available as security

If you use factoring:

• your customers may prefer to deal with you directly
• it may affect what your customers think of you if the invoice financier deals with them badly

Find funding

You can look for either:

• private finance providers (eg banks)
• public funding (eg government schemes)

Leasing and asset finance

Leasing or renting assets (eg machinery or office equipment) can save you the initial costs of buying them outright.

Advantages

Advantages include:

• you’ll have access to a high standard of equipment that you might not have been able to afford otherwise
• interest rates on monthly instalments are usually fixed
• it’s a less risky alternative to a secured bank loan - if you can’t make payments you’ll lose the asset but not, for example, your home
• the leasing company carries the risks if the equipment breaks down
• as long as you make regular repayments for the period of the lease, the agreement can’t be cancelled
• it’s widely available

Disadvantages

Disadvantages include:

• you can’t claim capital allowances on a leased asset if the lease period is less than 5 years (or 7 years in some cases)
• it can be more expensive than buying the asset outright
• some long-term contracts can be difficult to cancel early
• you may have to pay a deposit or make some payments in advance

Find funding

You can look for either:

• private finance providers (eg banks)
• public funding (eg government schemes)