At SME Loans, we realise that accessing the fast and affordable sources of finance your business needs to grow, can at times feel like an overwhelming task. With so many funding options out there, where do you even begin?
Whether you’re a business owner looking to grow your establishment into a thriving enterprise, or a budding entrepreneur with a big business idea – you’ll need to source a form of business finance.
Lucky for you, we’ve pieced together the ultimate funding guide for the small business owner or start-up entrepreneur who’s scouring the web for viable business financing options (that’s you!) There are 3 main business funding categories typically used by start-up businesses in the UK and within these 3 categories you will find a plethora of business finance options to choose from.
What are the Sources of Finance?
The sources of business finance can be split into three main categories, internal, external and personal sources of finance. Together they include forms of finance such as, retained profits, share capital, business bank loans, unsecured business loans, merchant cash advance, credit card pooling, savings and investments etc.
The 3 main categories that we are going to take a look at are:
What are the internal sources of finance?
1. Retained Profits
This one is a tricky one as it requires the business to start operating in order to turn a profit, before it is even a business. Whilst this might sound a little odd, it is actually quite common.
Many businesses do start trading before they officially start up, just to raise funds.
If, for example, you plan to import and sell a range of clothes, you might consider importing a starter batch of really cheap but 'trendy' caps or vests. You would then set about 'flogging' them to turn a quick profit.
The profit made is considered ‘retained profit’ and can be used to fund the business’ official start up.
2. Share Capital
By dictionary definition, share capital is:
‘money invested in a business in the form of shares rather than bonds or other forms of lending’
In other words, when a company is financed through share capital, one of the founders or partners may offer up the capital for the business in exchange for a portion of the company’s shares. Generally speaking the portion of shares is usually hefty.
IMPORTANT: This may not be the option for you if you don’t wish to have a co-founder or partner.
What are the external sources of business finance?
External sources of finance is funding that exists outside of the company such as from borrowing money from banks or creditors. Common forms of external business finance include business overdrafts, unsecured business loans, Government grants, merchant cash advances, venture capital, hire purchase, and more.
1. Bank Over-daft Facility
An overdraft facility from the bank can serve as a short-term financing option. Entrepreneurs who cannot get a suitably sized business bank loan often opt for this route, in their personal capacity.
This can be especially useful if you know that the business can turn a quick profit in the beginning stages, in order to quickly pay back the overdraft facility.
Banks allow their clients’ bank accounts to drop below zero (by prior arrangement) over the short term, but a fairly high interest rate is usually charged for this facility.
2. Business Bank Loan
High Street bank loans come with a lower interest rate and can be paid back over a long-term period (typically up to 5 years), but they are not easy to obtain. And for those that do qualify, it can take weeks to receive a decision and the pay-outs can also take some time.
Applicants must have:
A thorough business plan and cash flow projections to show the bank and prove affordability
A good credit score
Valuable assets to offer as collateral for the loan as security is usually provided in the personal capacity of the entrepreneur.
Overall, while business bank loans are a viable option for many big businesses, for smaller businesses and start-ups they’re not always the best funding route.
In short if you need funding quickly, have a less-than-perfect credit rating, or no personal security or business assets to offer, you’re probably best considering an alternative funding solution, such as a merchant cash advance.
3. Unsecured Business Loan
If a High Street bank isn’t a viable option for you, unsecured business loans are a firm favourite for many entrepreneurs, particularly if you’re a small business.
These loans typically require no collateral/security, have a quick & easy online application process, and can transfer funding within as little as 24 hours.
Business owners can loan anywhere between £1,000 and £500,000 in most instances.
Better still, bad credit business loans are also available online for those who may have a less than perfect credit score.
The only “downside”, so to speak, is that the interest rate can come in higher than that of a traditional bank loan. So, it’s best to calculate repayments first, to ensure that you can comfortably afford this source of business finance.
4. Venture Capital
Venture capitalists usually look for large high-tech businesses to invest in, and it’s not generally a common source of finance for small start-up businesses.
Venture capitalists are usually big-time investors looking to fund large risky projects in exchange for equity in the business. Which means, that once the money is provided, the investors have a say in the general running and operations of the business.
Be careful of this type of funding as it can place a lot of pressure on your start-up to produce a high return from a very early stage.
5. Government Grants and Subsidies
The United Kingdom government provides immense business finance support for entrepreneurs in the country. While government grants and subsidies are a viable option for many businesses, you do need to bear in mind that they usually come with tough qualifying criteria and the waiting period for such loans can often be lengthy.
6. Angel Investors
Angel investors are typically retired professionals or experts who provide funding as well as advice and business guidance to start-up companies. Their expertise and network of contacts is a viable route for quickly growing a business.
Angel investors aren’t the ideal source of finances for all entrepreneurs as often in exchange for funding, the investor will require a seat on the board of directors and have access to all business management information. However, for some entrepreneurs, the business expertise and guidance of an angel investor is invaluable.
7. Merchant Cash Advance
A merchant cash advance is technically not a loan and is instead an advance on the money your business is expected to generate through its future debit and credit card sales.
A merchant cash advance is a good funding alternative for small business owners because the amount you repay is always in sync with your business’ cash flow. If business is slow, your loan repayments are also nicely reduced, to ensure that you can always afford repayments.
Amounts vary from £5,000 to £500,000 and funding can be accessed within just 24 hours. Better still, an advance is also an unsecured and interest-free source of business finance, so the risks associated with this type of lending are considered minimal.
What are the personal sources of business finance?
Personal source of business finance is where the entrepreneur or business owner uses their own personal funds to help finance the business, it is particularly common with startups. This could be using personal savings to help fund business operations or providing assets for the business such as tools or transport.
1. Love Money (parent capital)
Love money is financing that is provided by a parent (parent capital), a partner (boyfriend, girlfriend, wife, or husband), family member or a friend. While this type of loan typically doesn’t have interest attached, a repayment is of course usually expected.
This type of loan is also widely regarded as the most risky. Not in terms of the repayments, but in terms of the “bad blood” that it can cause between two parties.
It’s not always a good idea to mix business and pleasure (money & loved-ones), so this source of finance should be approached with care.
2. Savings & Investments
When it comes to sources of business finance, using one’s personal savings and investment money is an option. It’s a risk-free way of getting the cash you need now and having no pressure from outside parties for repayment.
People who opt for this source of finance usually give a notice of withdrawal on their investments, withdraw their accrued savings, and put the money towards their official business capital amount.
3. Sale of Personal Property
Individuals who simply cannot get a loan or don’t want to put themselves into debt when starting a new business, opt for selling off their personal assets and property. This too is a source of financing that should be handled with care.
Entrepreneurs that go this route should only sell items and possessions that aren’t essential to their daily lives. For instance; selling the family car when you have to transport kids, to and from school, is probably not a great idea. However, if you have 2 cars available and can do without 1; this could be a viable route to take.
4. Credit Card Pooling
Most people have several credit cards in their personal names and opt for pooling the total of their available credit to pay for their start-up business costs.
While this is a quick way to acquire a lump sum, it is important to understand how credit card debt works and how it can quickly tie you into a long-term debt. Credit cards also come with a very high interest rate attached.
What is the best source of finance?
There is no ‘best’ source of finance, as what works for one business may not work for another. It is a good idea to compare different sources of finance before deciding what’s best for your business, especially when it comes to choosing an external source of finance.
Last Word
The best piece of advice that you can be given when starting up your business is to be as responsible with your finances and funding as possible. The greatest plan of action is to weigh up the financial and emotional pros and cons of each of the personal, internal and external sources of finance before settling on the option that is best suited to your needs and of course, your financial situation. Good luck!