The complete guide to business finance
According to the Government’s Department for Business Innovation and Skills, small businesses in the UK employ approximately one half of the country’s total workforce. What is more, the number of small businesses is increasing by as many as 500,000 every year.
In these two statistics alone, it is possible to appreciate the importance which the Government attaches to the growth of small businesses – a growth that, in turn, depends on the ready access to suitable business finance.
Given the demand for small business funding, what are the principal sources?
Perhaps the most traditional way in which companies raise funds is by offering to sell a share in the ownership of the company in return for an investment of cash. Investors therefore buy shares in the company and by so doing also share in the risks and profits that may be made.
Investment in return for a share in the ownership of the company is called equity investment. It is not a loan, so the company pays no interest on the money invested, but rather a dividend on the issued share capital, based on the company’s profits.
The source for such investment is typically referred to as venture capital and the investors themselves commonly called angel investors.
Although a company may depend on the financing available from angel investors, some small businesses may be concerned about the extent to which equity share holders may then demand a say in the way the business is being run.
Although venture capital may be one of the most traditional ways for small businesses to raise capital, the Department for Business Innovation and Skills recognizes that many such enterprises currently find it practically impossible to fund their businesses in this way.
A similarly traditional way of small business funding lies in the bank loan. The relationship between the manager of the high street bank and the local small business owner probably conjures up a quintessentially British picture of small town life.
The principle is simple. The loan advanced by the bank is repayable over an agreed – typically quite long – term through regular installments of both capital and interest.
It may be argued that bank loans for small businesses have never been entirely easy or straight forward to arrange. Before any advance is made, the bank is likely to demand sight of a fairly detailed business plan, outlining the principal streams of income and detailing the precise purpose for which the loan is going to be used.
In addition, the loan typically needs to be secured against the assets of the borrowing business – as the bank’s security against a failure to repay the loan if the business happens to fail. Security takes the form of a formal legal document, the drafting of which needs to be paid for by the borrowing business and which may also take some time to draft.
Just as with the difficulty in finding angel investors, the Government recognizes the lack of confidence amongst small businesses in the banks’ willingness to lend funds and has promised measures to instil greater trust and confidence in the banks.
British Business Bank
This is a Government-backed economic development bank intended to bring together both private and public sector funding for the benefit of small and medium sized enterprises in the UK. The partnership is expected to unlock up to £10 billion in additional funding within the next five years.
According to the Institute of Chartered Accountants of England and Wales, (ICAEW) the Government’s contribution of public funding through the British Business Bank totals £321.2 million. Of the £203.7 million so far invested by the combined public/private partnership, however, only 169 companies have benefitted.
In other words, release of the funds apparently available to this Bank is proceeding very slowly and may be difficult for many small and medium sized enterprises to access.
Small business loans
If funding from the British Business Bank may seem like a remote possibility to many small business owners, access to small business loans is quick, simple and very straight forward.
Lenders – like those of us at Merchant Money – typically operate a simple online application process through which a decision on whether or not to grant a loan may be made during the same working day. Once approval has been given, the requested funds may then be deposited into the applicant’s bank account within a matter of hours.
The typical size of such a small business loan is between £1,000 and £50,000, with a repayment term of up to 24 months – and with flexibility on both counts to suit the customer’s needs. Indeed, that same flexibility generally extends to the borrower’s decision to repay the loan in advance, without incurring any financial penalty.
Unlike many other business loans, these are essentially unsecured, except, in our case at least, for the personal guarantee of two of the applicant company’s directors.
Invoice financing takes advantage of the value of a company’s unpaid invoices – that is to say those sums that are owed by customers. It has traditionally been used by companies to raise additional finance in advance of the invoices being paid.
An advance against the value of unpaid invoices is made by a third party – the factor. As payments are collected from customers, the advance (plus a commission) is repaid to the factor.
In some cases the company holds on to responsibility for the collection of customers’ payments; in others, the responsibility is passed to the factor. When the company retains responsibility, the customers need not know that the business is invoice factoring; if a third party is collecting payments, then clearly the customers become aware of that fact.
Peer to Peer lending
In response to the scarcity of equity finance and the reluctance on the part of many banks to advance loans to small businesses, one of the increasingly popular alternatives is something called peer to peer lending.
This is based on the simple notion of bringing together businesses in need of borrowed funds with groups of small, individual savers willing to lend their money to the businesses concerned. In this way, the savers are able to earn a return on their savings rather higher than a savings account at the bank, and the borrowing companies are able to borrow at a lower rate of interest than that offered by a bank.
Lenders and borrowers are brought together through the services of a third party “platform” typically operating a dedicated website.
Equity crowdfunding is based on essentially the same principles as peer to peer lending. Groups of individual lenders or investors are brought together to provide small business finance.
Both peer to peer lending and equity crowdfunding are now regulated by the Financial Conduct Authority (FCA), which also refers to peer to peer lending as “loans-based crowdfunding” and equity crowdfunding as “investment-based crowdfunding”.
Imagination and innovation
The list of business finance sources identified above is by no means exhaustive. In a rapidly changing economic world, new and imaginative sources may be developing all the time.
If you are the owner of a small business in search of additional funding, therefore, it may repay you exercise similar imagination in the places you might look for the finance you need – the old financial order may be changing, and with it may be coming fresh new opportunities for securing just the type of funding to suit the current needs of your small business.