Sources of Finance

Funding options for companies

 

There are lots of options open for businesses trying to raise funding and it would be impossible to cover them all here. That doesn’t necessarily mean that raising funding can’t be challenging, particularly if a business is new and cannot produce a trading history. Appropriate funding streams are determined by a number of factors, such as:

  • The maturity of the business; whether it is a new, growing or or an established concern;
  • The sector the business operates in;
  • Whether the business has assets that can be secured against any borrowing;
  • The expectations of potential investors; and
  • To what extent the business owners want to retain full control.

Bootstrapping and friends and family

Bootstrapping is when people finance a new
business using capital and credit available to them in the form of
savings, overdrafts and credit cards. Obviously this is risky because if
the business fails, the debt will still be owed. Borrowing from friends
and family is equally risky, although this time the risk lies with
them. They have no real evidence that you can make a success of your
enterprise, and lend the money as an act of faith in the entrepreneur.
They should only do this on the understanding that they might lose their
investment.

Sources of Finance Expalined

Crowdfunding

Crowdfunding is where a small group of
investors decide to take a risk and back the business. It is useful in
situations where the business has no access to capital and is unable to
borrow. With crowdfunding each investor provides an unconditional grant.

Bank loans and overdrafts

Whilst it is always possible to apply for a
business loan, and banks often look favourably on applications, bank
loans represent an inflexible form of business finance with rigid
repayments set over a specified period; lenders will require information
about the business and possibly security against the loan. Overdrafts
attract a higher rate of interest than loans, can be cancelled by the
bank at short notice and, except in the case of large businesses with,
at least, hundreds of thousands of pounds in annual turnover, are
unlikely to be large enough to provide the level of funding required.
Banks are likely to look more favourably on businesses that already hold
accounts and do business with them.

Venture capital

If a business is looking to expand in new
markets it may be able to attract venture capital. Venture capitalists
are shrewd investors who will examine the business in some detail before
advancing funding. Their ultimate aim will be to make their investment
work to increase the overall value of the business so that it can be
sold at significant profits for both themselves and the business owner.

Invoice financing

Invoice financing is a good way for a
business to ease its cash flow problems and free up its working capital.
Invoice financing work on the principle of a lender advancing finance
on the basis of outstanding invoices as soon as they are raised; the
business clears the borrowing once the customer pays the invoice. There
are several methods of invoice financing.

Invoice Factoring

With invoice factoring a business loses some
control because it hands over its sales ledger to the factoring company
who obtains payment from the customer and, in addition, undertakes
credit checks and other credit control functions. As customers of the
business will know it is using a factoring company, it needs to work
with one that doesn’t alienate customers who, as a consequence, might
decide not to trade with that business in future. For new businesses in
particular, using a factoring company frees up time the business can
spend promoting trade and building relationships with its customers.

Invoice discounting

Invoice discounting works in a similar way
to factoring, except the business retains control of its invoices,
credit checks and credit control functions. The lender advances a
percentage of the value of each invoice which the business repays when
the customer settles it. Unlike invoice factoring, invoice discounting
is not evident to customers. However, to be able to secure an invoice
discounting facility a business has to be quite mature with a
significant annual turnover.

Asset financing

Businesses can raise funds through asset
financing by using its existing assets as security against which to
raise capital for development, or it can take out finance to buy new
ones.

Asset backed lending

Asset based lending is very straightforward and
money obtained and secured on the basis of a valuable asset is often
termed refinancing. If the business fails to make repayments the lender
may take possession of the asset. Whilst there are a number of asset
based lending schemes on the market, all with slightly different
conditions, two basic conditions are:

  • The asset must be crucial to the business; and
  • The asset must be transportable so that if the need arises it can be removed by the lender.

Funding new assets and equipment

In order to avoid any capital outlay which
could deplete it’s working capital or affect cash flow, a business might
choose to borrow to buy new assets.

Equipment leasing

With equipment leasing, the lender buys the
asset and leases it to the business. The only initial outlay for the
business is the first monthly instalment. At the end of the agreed lease
period the business has the opportunity to buy the asset and payments
made to date are reflected in the selling price. Other alternatives
include renewing the lease or taking out a new lease on a more
up-to-date version of the asset.

Hire purchase

Business hire purchase agreements work in a
similar way to domestic hire purchase. Unlike leasing the business owns
the asset. There is no initial outlay other than a deposit and monthly
instalments. There are some important considerations that a business
needs to make before taking out hire purchase, including:

  • In order to make the hire purchase
    worthwhile, the asset needs to be integral to the business. If it will
    only be required for a limited time leasing might prove a better option;
  • How much the asset will depreciate over the hire purchase
    period. Although, if the asset is an integral component of the business
    and has a long life, depreciation is unlikely to be important; and
  • Consider how frequently the manufacturer of the asset
    releases a new version. Having the latest model of a haulage wagon may
    not be that important, whilst having the latest packing machine that
    does so much more than the previous version could be very important.

Property development

Businesses operating in property development or investment have a variety of options by which to raise capital.

Commercial Mortgage

A commercial mortgage is used to buy any
premises not classed as residential. Commercial mortgages operate like
domestic mortgages and are usual taken out to buy premises at business
start-up, or buy premises that were previously rented.

Auction finance

Property can often be bought at auction
fairly cheaply. However, the winning bidder has to be able to settle the
bid, usually within 28 days. Some lenders specialise in this type of
funding and will provide a guarantee prior to the auction taking place.
Even less established property buyers may be able to secure auction
finance once a bid is won and the deposit (usually 10%) has been paid.

Bridging Finance

Bridging loans are usually taken out to
finance property development, with the nature of the agreement
determined by the scale of the project. For example, a bridging loan
might be taken out quickly to finance essential refurbishment work that
could leave the business in a more profitable position after 3-12
months, by which time a mortgage will have been obtained to clear the
bridging loan. Bridging finance
is expensive and should only ever provide a short-term solution to
borrowing requirements until a longer term solution can be found.

Stock finance

Stock finance works in a similar way to
asset finance in that borrowing is secured on stock, rather than other
tangible assets. Lenders operating in this market will want to examine
and monitor who the business buys from and sells to, and also the volume
of trade.

Merchant Credit advances

Merchant credit advances are suitable for
retail businesses where income comes mainly from card payments by
customers. The lender will determine the monthly average of payments
taken in this way by the business and agree to lend a certain amount
based on that. Repayment terms are flexible and are usually based on a
percentage of the monthly takings. This means that a business pays more
in months where it’s income is greatest, and pays less when there has
been a downturn in sales. What is more, the lender deals directly with
the company that process the card transactions, deducting the loan
repayments at source.

Advantages of merchant credit

  • The money never comes
    into the business bank account, so business owners don’t have to worry
    about making the repayment. This frees-up time the business can spend on
    other activities;
  • Repayment terms are set at a level that corresponds to the volume of business done; and
  • Credit options for the remainder of your business remain open.

Disadvantages of merchant credit

Although merchant credit can be an excellent
way for a retail business to raise capital it does have some
disadvantages, including:

  • The amount that can be lent is directly
    related to sales, so this may not be enough to finance the purchase of a
    large asset, expansion, or company redevelopment;
  • If the business takes in money through a variety of
    sources, such as card, cash and bank transfer, the monthly amount of
    card payments may to be insufficient to to make merchant credit a
    workable option;
  • Choice of lender might be limited to the companies your card processor deals with.

Pension led funding

It is possible for a business to raise funds from the pension pot of a director, providing:

  • The pension pot has a value of at least ₤50,000;
  • The director knows and is in agreement; and
  • The pension provider agrees.

This type of lending can be tailored to suit the Director’s and
Company’s requirements.

A final word

The sources of lending covered above are by
no means exhaustive. Peer-to-Peer lending is becoming very popular and
there is a range of Government grants available to businesses who meet
the criteria. Equity investment can also be a good way for a limited
company to raise money, providing it is happy to take additional
investors on board who may want a say in future business decisions. Some
of the financing methods mentioned above can be extremely complex and
so the advice to any business considering taking on any form of
borrowing is to take independent financial and legal advice. To take on
borrowing, without fully understanding what the liabilities and
responsibilities are, put both the business, and possibly personal
assets at risk.