Small businesses have many options for business financing. But this, in itself, can be overwhelming, particularly for start-ups focusing on multiple strands of growth. Deciding which finance option is best for your small business is imperative for growth plans to succeed. Here’s a breakdown of some of the types of business finance for start-up companies.
Defining business finance
Business finance for start-up – what is this? It refers to any funding raised by start-ups to help them grow. There are two main types of business finance:
- Debt finance – where a business borrows money from a lender and agrees to pay back in full plus interest. The money can be paid back in a lump sum, or through a long-term payment plan. The business does not have to give up any control or shares to access funding in this way.
- Equity finance – when a business raises funding by effectively selling shares to investors or another business. The stake’s value depends on the success of the business selling, which means investors retain an interest in its profitability and growth. Often, investors also bring their experience, skills and networking to the deal, in order to help the business grow.
It is rare for a start-up to be able to fund itself independently, which means the vast majority must raise business finance of some kind.
Which business finance should a start-up choose?
Both debt and equity finance both have pros and cons for small businesses.
- What are the advantages of debt finance for small businesses?
- Tax relief is available on interest payments.
- It’s relatively simple to plan ahead to make repayments.
- Terms can be tailored in the best interests of the business.
- What are the disadvantages of debt finance for small businesses?
- Penalty charges apply if you default on payments.
- Cashflow can fluctuate, which could affect the ability to pay.
- Lenders will analyse business and personal credit history.
- What are the advantages of equity finance for small businesses?
- Investors can provide further funding as the business grows.
- Investors can bring invaluable skills, expertise and resources to the table.
- Investors take on some of the risk as they own a share and want to help the business succeed.
- What are the disadvantages of equity finance for small businesses?
- Businesses dilute ownership.
- There are lots of legalities to cover.
- Raising equity demands time away from the business.
Business financing is the lifeblood of a small business, and particularly start-ups. The most recent analysis from the Office of National Statistics (ONS) shows the business ‘death rate’ is continuing a steady rise (for a number of years). This is stark evidence of just how tough it can be out there for small businesses and start-ups that want to survive and grow.
Potential sources of business funding for small businesses
Following the financial crisis in 2008, some traditional forms of financing for businesses dried up. This opened the door for some alternative, or less traditional forms of funding, for example, crowdfunding. Here are some of the main sources of funding available for both categories, starting with debt finance.
- Bank loans – work well for large, long-term investments.
- Bank overdrafts – useful to fund shorter term business plans or finance day to day working capital.
- P2P lending – peer-to-peer lending uses online platforms that match borrowers with potential lenders. Loans can be small amounts or go up to millions. The platform charges a fixed fee or lenders outbid each other with competitive interest rates.
- Asset-based financing – this covers both asset-based lending and invoice financing.
- Hire purchase and leasing – useful for physical assets like company cars and office equipment. The option to buy is generally available at the end of the agreement. Works well for businesses that need equipment but can’t afford to buy outright.
- Export finance – this covers a number of financial banking products designed to make it easier for businesses to trade internationally. It reduces defaulting risks or delayed payments, and bridges payment gaps when necessary.
- Trade finance – helps businesses buy goods from domestic and international sellers. This generally covers specific goods shipments over set periods of time.
- Mezzanine and growth finance – both of these are tailored to the needs of a business, so that the repayment plan matches its revenue forecast. Usually used to fund the expansion of existing businesses.
Potential sources of equity financing
- Angel investment – ‘angel’ investors are wealthy people who put money into businesses in return for equity. They either invest alone or through a syndicate.
- Equity crowdfunding – uses online platforms to link angel investors with businesses needing funding.
- Venture capital – venture capitalists seek out unique businesses they believe will deliver high returns. They invest in a number of businesses, knowing that a percentage will fail. Often invest in early stage start-ups.
- Private equity investors – they aim to improve a business’ profitability and to do so invest in new services and products, or into plans for expansion. They introduce a corporate and management structure to the business. The investment goes on for around five to seven years, after which the investor sells its shares and lists the company publicly.
James Turner, Managing Director of Turner Little Limited says: “This is not an exhaustive list of all forms of business financing, but it is a useful basis for start-ups unsure how to proceed. All small businesses need to access some kind of funding, and while it can seem a distraction in terms of time invested in securing the right kind of funding, it is key to growth.”
“Small business and start-up owners should carefully consider which form of funding is right for their needs. It may be that as they grow and expand, the type of finance needed changes. It’s always a good idea to engage a professional for advice on the best kind of funding for your business, particularly if you’re starting out.”
About Turner Little
Founded in 1998 in Yorkshire, UK, Turner Little is a specialist UK and offshore company formation, banking and corporate services provider. Our services include company formation, UK and offshore banking, asset protection, credit correction, trademarking and trusts. Other services include Internet services, mail forwarding, wills and probate. Turner Little’s vision is to offer the best possible service, together with market leading products.