Many new businesses fail because the proprietors do not have enough cash to last them through the critical first few months of trading while their sales revenues are only just starting to build up.
Before you begin trading, you need to make sure you have enough money to set up the business and cover your initial running costs. If you or your business partners don’t have enough money yourselves, you will need to approach other sources of finance.
Potential sources of finance for new startups:
- Personal savings and informal loans from family or friends.
- Credit cards.
- Private equity investors.
- Government sources of funding.
- Local authorities.
- Community Development Finance Institutions (CDFIs).
- Other business support organisations.
Helpful hints and tips before you get started:
- A local business adviser will be able to advise you about the sources of finance available in your local area and can help you to apply for finance.
- All providers of finance will need to be convinced about the viability of your business and you will therefore need to produce a robust business plan, explaining how your business will operate and why the finance is required.
- Outline your objectives and how you plan to achieve them in your business plan. You should include precise details and justification for the finance you need and when you will need it.
- Be sure that you can afford repayments on any loans, either personally or through business profit.
- Financial assistance, especially for business start ups, is sometimes dependent on you attending business skills training courses, which not only improve your personal skills but also increase the confidence of potential investors in your business.
- Carefully check your eligibility for a particular grant before applying, as there can be strict qualifying criteria and the application process can be time-consuming.
So here we go! The following is meant as guidance only but is a full comprehensive summary of the options of finance available to your start up.
Personal savings and money raised from friends and family
Personal savings and money raised from friends and family are the most common forms of finance for start ups. Friends and family may be prepared to help you start your business by offering you a loan, particularly if you cannot get one from a bank. This may be on preferential or ‘soft’ terms, including the possibility of an interest-free loan. If you opt to pay interest there will be tax implications for both parties. However, personal relationships may be affected if your business does not do as well as planned and you are unable to repay the loan on time or in full.
Relatives or friends may also consider investing money in your business in return for a share of its ownership, even if they act as a ‘sleeping partner’. However, they need to understand that they will be risking their capital and that returns are not guaranteed, so they should invest only what they can afford to lose. This type of investment also has implications relating to the legal status of your business.
Banks offer a variety of finance options, services and introductory offers to business start ups. Banks can provide finance in the form of an overdraft, whereby they agree to let you withdraw more money than you actually have in your business account. Your bank will set a maximum level for your overdraft.
You only have to pay interest on the amount you are overdrawn, so overdrafts can be a good option if you only need small amounts of extra cash at certain times during the month or year. However, the interest you pay is often higher than the rate for a loan.
Business loans are available through the major high-street banks and it is important to shop around for the best deal for your own personal and business circumstances. You should consider the amount you need to borrow, the rate of interest charged and the repayment period that you can afford. If you are starting a business, it is likely that your loan will need to be secured against a personal asset such as your house.
Some businesses fund their short-term spending through the use of credit cards. This has been encouraged by the availability of competitive deals such as introductory interest-free offers.
While many credit card providers discourage the use of personal credit cards for business purposes, there are now a number of credit card offers specifically targeted at new business owners.
Credit cards can help a business to finance its short-term needs, but they don’t make sense for long-term borrowing. Although initial interest rates may be attractive, the interest costs of credit cards are usually higher than overdrafts and loans, unless you can repay the outstanding balance each month.
Private equity investors
Private equity is money that is invested in your business by a third party in return for a share of the ownership. This may be provided by a commercial organisation such as a venture capital firm or private investors who are known as business angels. This type of finance is available only to limited companies. Private equity funding is not available for businesses that operate under a sole trader or partnership legal status.
Private equity is not usually secured on a company’s assets, so the investor faces the same risks as the other shareholders. If the business fails they will lose their money. Investors achieve a return on their investment through the payment of dividends by the company and the value they achieve for their shares when they are sold.
Venture capital is a means of financing a business where a proportion of your business’s share capital – or equity – is sold in return for a cash investment in the enterprise.
It means that some measure of control or ownership over your business has to be given to the new shareholder. Most, but not all, venture capital investors are looking to make quite large investments, often over £1 million, which excludes them from providing finance to the majority of start-ups. The British Private Equity and Venture Capital Association (BVCA, www.bvca.co.uk) publishes a list of member firms, their contact details and the types of funding that they provide.
Business angels are private investors who look for opportunities to invest money into new or growing businesses. Most regions of the UK now have business angel matching services, which encourage local investment and mentoring on a smaller scale. The UK Business Angels Association (www.ukbusinessangelsassociation.org.uk) matches business angels with small businesses requiring equity finance. Angels Den (www.angelsden.com) runs regional workshops for businesses looking for angel funding. Business angels are typically looking to invest funds of between £10,000 and £100,000, although they can also form syndicates of investors who will invest larger amounts.
Equity based crowdfunding
Crowdfunding is a method of financing that enables a large number of people to invest a very small amount of money in a business. A business seeking investment is usually matched with potential investors online via specialist crowd funding platforms such as Crowdcube (www.crowdcube.com) , Crowd2fund (crowd2fund.com) and Seedrs (www.seedrs.com).
Equity crowdfunding enables groups of investors to receive shares in the business in exchange for their investment. The value of their stake in the business can go up or down, as with any investment in shares.
The UK Crowdfunding Association has published more information about crowd funding, which can be viewed at www.ukcfa.org.uk.
Government sources of funding
A variety of initiatives operated by the Government offer help to business start ups, particularly those involved in technology, research and development (R&D) and exporting.
Grants provide finance to allow your business to undertake a specific project that, without financial assistance, would not be able to proceed. Such projects might involve the initial start up of the business, developing a new product or buying equipment.
A grant is usually a one-off payment and provides funding that covers a percentage of the costs of the project – normally you or your business will have to meet some of the costs too.
Unlike a loan, a grant does not usually have to be repaid unless you fail to comply with the specific eligibility requirements and conditions of the scheme. You will need to check that you meet the eligibility criteria for a particular grant and consider what will be required to satisfy the funders’ requirements. See BIF 369, A Guide to Applying for a Business Grant for detailed information about the process of securing grant funding.
The most widely available Government-funded grants are for R&D, but various grant schemes are available in the different regions of the UK.
Start Up Loans
Start Up Loans is a national scheme that provides loans to people of any age to help them start up or develop a business that has been trading for less than 12 months. The average loan amount is £5,000 and mentoring and support is provided to successful applicants. Go to our partner’s website www.startupdirect.org for more information.
New Enterprise Allowance (NEA)
The NEA is an initiative funded by the Department for Work and Pensions (DWP) that helps unemployed individuals to start up their own business.
To be eligible, an individual must be aged 18 or over and be claiming Job Seekers’ Allowance (JSA) or Employment and Support Allowance, and applicants can access the allowance from the first day of their claim. Lone parents who receive Income Support are also eligible to apply.
The NEA provides access to a mentor and financial support comprising £65 a week for 13 weeks, reducing to £33 a week for a further 13 weeks. Participants on the NEA may also apply for a loan of up to £1,000 subject to status, to help towards the costs of starting their business. Go to www.dwp.gov.uk/adviser/updates/new-enterprise-allowance for further information about the scheme.
The Economic Development Department (or equivalent) at your local authority may offer financial support to new and existing businesses, including grants and loans. Many local authorities also provide managed workspace units that offer low-cost office space for new start ups.
Community Development Finance Institutions (CDFIs)
Community Development Finance Institutions (CDFIs) specialise in providing finance to new and growing businesses that have been unable to secure finance through traditional routes such as bank loans. Most CDFIs are members of the Community Development Finance Association (CDFA, www.cdfa.org.uk), which can provide further information and the contact details of your nearest CDFI.
Other business support organisations
A number of locally based business support organisations administer a variety of schemes to help support new and expanding small businesses. Many of the schemes include business planning advice, training and some form of financial support.
Local enterprise agencies
Enterprise agencies provide advice and financial support to pre-start, start up and micro businesses. They will also be able to signpost you to other local sources of financial support.
The main types of finance provided by enterprise agencies are:
- Soft loans, which often require no security and are used to support viable businesses that cannot raise all of the finance they need from other sources.
- Grants, which may have narrow eligibility criteria. For example they may only be available in certain geographic areas or for certain business sectors, or for specific types of people (for example unemployed or young people) or projects (for example marketing or buying IT equipment).
Go to www.nationalenterprisenetwork.org for your nearest enterprise agency.
The Prince’s Trust and Youth Business Scotland
The Prince’s Trust and Youth Business Scotland help young people aged between 18 and 30, who are unemployed or under-employed, to start up in business. The trusts are aimed at disadvantaged young people who find it difficult to obtain finance from conventional sources. They operate from regional offices, arranging advice and training as well as grants and loans.
Shell LiveWIRE supports young people aged between 16 and 30 anywhere in the UK who are either planning to start a business or are in their first year of trading. Shell LiveWIRE runs two business awards: the monthly £1,000 Shell LiveWIRE Grand Ideas Award and the annual £10,000 Shell LiveWIRE Young Entrepreneur of the Year Award. Go to www.shell-livewire.org/awards/ grand-ideas-awards for further information.
So as you can see there are many options to pick from, which one is right for your startup?