By Vicki Taylor on Small Business UK – Advice and Ideas for UK Small Businesses and SMEs
A look at the key options available when it comes to funding your business. What do they involve, and which is the best fit for various types of businesses?
Businesses today face numerous economic challenges, including the cost-of-living crisis, record-breaking inflation levels, skills shortages and increased pressure to maintain a healthy profit. Some of these challenges are already placing a squeeze on firms’ cash flow but now with interest rates also on the rise, the cost of borrowing – for consumers and companies alike – has increased.
>See also: Raising start-up capital – who to turn to?
The good news is that if your business wants to strengthen its financial position or capitalise on changing market conditions to accelerate growth, you do still have plenty of funding options available.
#1 – Debt funding
Debt funding is when a business raises capital via a loan, usually from a bank or another lender. Over the term of the loan, the borrower is expected to pay back the full amount, as well as any interest that is accrued – much like a personal loan.
Usually, raising capital in this way does not affect the overall ownership of a business, meaning the lender would have no influence in how your business is run day-to-day, which is the key distinction between this type of funding and equity finance.
Raising capital via debt is therefore a good option for business leaders that do not wish to dilute equity – or for businesses that have already raised equity capital and need to raise more cash, but do not want to dilute equity any further.
It is also a good option if your business is fast-growing or has recurring revenue. Fast growth firms often have high upfront costs, such as employee overheads and product development and need additional working capital to take their business to the next level. Debt funding will give you access to the capital you need to accelerate this growth and you can then repay the loan, plus the interest, as your revenue grows.
Likewise, the nature of businesses with strong recurring revenue makes them a good match for debt lenders, as there is clear visibility on the serviceability of the loan.
#2 – Venture debt
Venture debt is a specific type of debt funding aimed at earlier-stage businesses – this is often a good match for firms that are pre-profitability but can demonstrate a clear plan as to how they will get there.
Often these businesses do not meet the eligibility criteria for traditional loans, so the cost of venture debt is usually higher to encompass the increased risk to the lender, but by working with a specialist venture debt provider, you are more likely to find a tailored solution that fits your particular growth needs.
#3 – Equity funding
Equity funding can be provided through a variety of mechanisms, including private equity, venture capital and angel investors. The fundamental difference between debt and equity funding is that the latter involves divesting equity; in exchange for an agreed sum, the investor will take a percentage ownership of your business.
The benefit of equity funding is that because the investor receives upside in the form of equity, your business does not need to make regular repayments, or pay interest, which makes it a great way of raising capital with minimal impact on cash flow.
Equally, for less mature or less established businesses, you get the benefit of the investor’s experience, which, depending on the investor you choose to partner with, could be incredibly valuable in developing your business strategy.
Crowdfunding can also be a form of equity finance – you just sell a percentage stake in your business to multiple people, rather than to a single investor or institution.
For businesses that are just beginning their growth journey, equity crowdfunding can be a lower-risk way of raising capital, but this all depends on how comfortable you are selling a stake in your company. If equity dilution is not for you, there are many other funding options that will be more suitable.
>See also: Crowdfunding UK small business: everything you need to know
#4 – Invoice finance & discounting
If your business relies on invoice payments as its main source of income, it may be among the 36 per cent of UK SMEs which wait between 30 and 90 days to get paid. These long payment terms can play havoc with cash flow and leave very little left over to reinvest in growth or business expansion.
Invoice finance solves this problem, enabling businesses to secure an advance on unpaid invoices – usually between 80-90 per cent of the invoice value. This puts the outstanding capital back in your hands so that you can spend it however you see fit.
Most lenders will offer a range of invoice facilities. Selective invoice finance, for example, enables businesses to secure funding on an invoice-by-invoice basis, meaning you can pick and choose the invoices you advance and essentially pay as you go with the associated fees.
Invoice discounting on the other hand, enables a business to leverage a larger amount of cash by advancing funding on a pool of invoices or debtors. This type of invoice finance is more useful for organisations that have specific uses for the capital in mind, because it usually raises a larger total sum. This sum can then be used for a variety of things – whether that is building a working capital buffer to strengthen cash flow in challenging market conditions, or something more growth-orientated, such as merger and acquisition activity, hiring more staff, or investing in product development.
Some specialist lenders will also offer specific multi-currency invoice finance facilities. These facilities are perfect for businesses that operate internationally, such as exporters and manufacturers, as it enables you to secure funding in the currency your invoices are raised in, rather than face hefty conversion charges.
#5 – Growth loans
Technically, all of the above can be considered growth loans, as the primary characteristic of a growth loan is that the capital raised is used to help a business grow.
The concept of a growth loan usually fits more with businesses that have a specific use for the funding in mind, particularly where that use is growth orientated. This could be for a number of reasons, including to execute mergers and acquisitions, to invest in research and development, or to expand into new premises, or hire more employees.
For this reason, term loans, venture debt, equity funding and invoice discounting fit more easily under the banner of “growth loans”, because they are more often used to fund specific strategies that accelerate a business’ growth.
#6 – Working capital
Working capital is similar – many different products, including invoice finance and term loans, can provide a business with working capital. The distinction between this and a growth loan, is that working capital is more often used to cover cash for day-to-day operations, rather than specific growth strategies.
However, for some businesses, increasing their available working capital means that they have more money to spend on things such a sales and marketing activity, which ultimately should contribute towards the growth of their business, so there is some crossover between the two definitions.
The importance of research
Financing a business can be an intimidating process, especially given the pressures of the current economic climate. Conducting some research on the above – and any other financial products that you think might be a good fit – is a good start. if you are still struggling, working with a finance advisor can be a great way of improving your knowledge of what is available. They will understand the nuances of each particular lender, as well as their lending criteria, risk appetite and associated fees and can usually offer an introduction once you have narrowed down your business funding options. Of course, there will be fees involved when you go down this route (usually made up of a fixed fee and then a percentage-based ‘success fee’) but like any consultant, if you take time to find a good one the benefits can be significant.
Online search is your friend too – most lenders have online calculators and application forms, so if you want to find out more, start reaching out. The ultimate takeaway is that the earlier you start looking in the fundraising process, the more business funding options you will have and therefore a better chance of finding something that is the right fit.
Vicki Taylor is principal at Growth Lending
More on business funding options
Finance and support for your business – The Department for Business and Trade provides this useful list of finance schemes on offer from various UK local and regional government bodies.
Alternative business funding for small businesses – A comprehensive review of the sources of finance available outside of the ‘normal’ channels.
Small business startup funding – A guide to funding options available to get you through those early days.
Build Back Better #1 – equity vs debt, which is better? – Which is better when you want to grow your business, equity or debt? Ian Dawson examines the case for either.
A complete guide to business finance – Exploring the top ten options for SME finance and advice on where to find providers.
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