Many new businesses fail because they do not have enough cash to last them through the critical first few months of trading when their sales revenues are only just starting to build up.
Before business owners begin trading, they need to make sure they have enough money to set up the business and cover initial running costs. If they or their business partners don't have enough money themselves, they will need to approach other sources of finance.
This article outlines some of the options available for sourcing external cash to help people start up in business. There are various sources of finance available, but for new start ups, the most likely options will be:
- Personal savings and informal loans from family or friends.
- Bank loans and overdrafts.
- Credit cards.
- Private equity investors, including business angels.
- Crowdfunding, where money is raised from large numbers of individual investors.
- Government funding schemes.
- Responsible finance providers (RFPs).
- Credit unions.
- Other independent business support organisations and schemes.
Personal savings and informal loans from family or friends
Personal savings and money raised from friends and family are the most common forms of finance for start ups.
Friends and family may be prepared to help start ups by offering them a loan, particularly if it has not proved possible to get one from a bank. This may be on preferential or 'soft' terms, including the possibility of an interest-free loan. If friends and family offer a loan, but require interest to be paid, then there will be tax implications for both parties. In addition, personal relationships may be affected if the business does not do as well as planned and the business owner is unable to repay the loan on time or in full.
Relatives or friends may also consider investing money in a business in return for a share of its ownership, even if they act as a 'sleeping partner'. However, they need to understand that they will be risking their capital and that returns are not guaranteed, so they should invest only what they can afford to lose. This type of investment also has implications relating to the legal standing of the business.
Bank loans and overdrafts
Banks offer a variety of finance options, services and introductory offers to business start ups. For example, many banks offer an introductory period of free banking, and this can last for up to two years in some cases.
Banks can provide finance in the form of an overdraft, whereby they agree to let business owners withdraw more money than they actually have in their business account. The bank will set a maximum level for the overdraft.
Firms only have to pay interest on the amount they are overdrawn, so overdrafts can be a good option if only small amounts of extra cash are needed at certain times during the month or year. However, the interest payable is often higher than the rate for a loan.
Business loans are available through the main high-street banks and the recently established challenger banks, such as Metro Bank and OakNorth, and it is important to shop around for the best deal for both personal and business circumstances. Factors to consider include the amount to be borrowed, the rate of interest charged and the repayment period that is affordable. For a business start up, it is likely that the loan will need to be secured against a personal asset such as the proprietor's house or other property.
Some business start ups fund their short-term spending through the use of credit cards. This has been encouraged by the availability of competitive deals such as introductory interest-free offers. While many credit card providers discourage the use of personal credit cards for business purposes, there are now a number of credit card offers specifically targeted at new business owners.
Credit cards can help a business to finance its short-term needs, but they don't make sense for long-term borrowing. Although initial interest rates may be attractive, the interest costs of credit cards are usually higher than overdrafts and loans, unless the business owner can repay the outstanding balance each month.
Private equity investors
Private equity is money that is invested in a business by a third party in return for a share of the ownership. This may be provided by a commercial organisation such as a venture capital firm or private investors who are known as business angels. This type of finance is available only to limited companies. Private equity funding is not available for start ups that operate as a sole trader or business partnership legal structure.
Private equity is not usually secured on a company's assets, so the investor faces the same risks as the other shareholders. If the business fails, they will lose their money. Investors achieve a return on their investment through the payment of dividends by the company and the value they achieve for their shares when they are sold.
Venture capital is a means of financing a business where a proportion of the firm's share capital - or equity - is sold in return for a cash investment in the enterprise. It means that some measure of control or ownership over the business has to be given to the new shareholder. Most, but not all, venture capital investors are looking to make quite large investments, often over £1 million, which excludes them from providing finance to the majority of start ups. The British Private Equity & Venture Capital Association (BVCA, www.bvca.co.uk) publishes a list of member firms, their contact details and the types of funding that they provide.
The UK Crowdfunding Association has published more information about crowdfunding, which can be viewed at www.ukcfa.org.uk.
Government sources of funding
Various initiatives are operated by certain government departments and agencies that offer help to business start ups, particularly those involved in technology, research and development (R&D) and exporting.
Grants provide finance to allow a business to undertake a specific project that, without financial assistance, would not be able to proceed. Such projects might involve the initial start up of the business, developing a new product or buying equipment.
A grant is usually a one-off payment and provides funding that covers a percentage of the costs of the project - normally the proprietor or the business will have to meet some of the costs too. Unlike a loan, a grant does not usually have to be repaid unless the business fails to comply with the specific eligibility requirements and conditions of the scheme. Business owners need to check they meet the eligibility criteria for a particular grant and consider what will be required to satisfy the funders' requirements.
The most widely available government-funded grants are for R&D, but various grant schemes are available in different regions of the UK www.gov.uk/business-finance-support-finder/search or contact Swindon and Wiltshire Growth Hub were we can search a massive number of grants for you.
Some government departments, such as the Department for Environment, Food & Rural Affairs (Defra, www.gov.uk/government/organisations/department-for-environment-food-rural-affairs), and other organisations such as the UK's Arts Councils (www.artscouncil.org.uk, www.creativescotland.com, www.arts.wales and www.artscouncil-ni.org), may also offer funding schemes for business start ups in specific sectors.
Start Up Loans
Start Up Loans is a national scheme that provides loans to people aged 18 and over to help them start up or develop a business that has been trading for less than 24 months. Loans are repayable over one to five years, and the interest rate is currently fixed at 6%. Loans of up to £25,000 are available, and the average loan amount is £6,000. Applicants for a Start Up Loan must be at least 18 years old and resident in the UK, with the legal right to remain in the UK for the term of the loan. Applicants must not have been, or currently be, declared bankrupt and/or have any outstanding Individual Voluntary Arrangements (IVAs). Mentoring and support are provided to successful applicants.
Go to www.startuploans.co.uk for further information or look out for our Business Planning and Finance workshops on our events page.
New Enterprise Allowance (NEA)
The NEA is an initiative funded by the Department for Work and Pensions (DWP) that helps unemployed people to start up their own business in England, Scotland and Wales.
To be eligible, applicants must be aged 18 or over and be claiming Jobseeker's Allowance (JSA) or Employment and Support Allowance; applicants can access the allowance from the first day of their claim. Lone parents or people who are sick and receive Income Support are also eligible to apply. Some people who receive Universal Credit may also be eligible.
The NEA provides access to a mentor and financial support comprising a weekly allowance paid for up to 26 weeks (up to a total of £1,274). Participants on the NEA may also apply for a Start Up Loan, subject to status, to help towards the costs of starting their business. Go to www.gov.uk/government/collections/new-enterprise-allowance-campaign for further information about the scheme.
Some economic development departments (or equivalent) in local authorities may offer financial support to new and existing firms, including grants and loans. Many local authorities also provide managed workspace units that offer low-cost office space for new firms.
Responsible finance providers (RFPs)
RFPs specialise in providing finance to new and growing firms that have been unable to secure finance through traditional providers such as banks. Most RFPs are members of Responsible Finance (RF, http://responsiblefinance.org.uk), which can provide further information and the contact details of the nearest RFP. RFPs were previously known as Community Development Finance Institutions (CDFIs).
There are more than 500 credit unions in the UK, with an annual turnover of over £182 million. They distribute their profits to members in the form of dividends.
Some credit unions provide loans for small firms, especially for new business start ups. Go to https://northlondoncreditunion.co.uk/business.html#startups and www.centralcu.co.uk/content.asp?section=232 for examples of credit unions that provide funding for business.
The Association of British Credit Unions Limited (ABCUL) is the main trade body representing credit unions in England, Scotland and Wales. Go to www.abcul.coop for further information and to find a local credit union.
Independent business support organisations
A number of locally based business support organisations administer a variety of schemes to help support new and expanding small firms. Many of the schemes include business planning advice, training and some form of financial support.
Local enterprise agencies
• Grants, which may have narrow eligibility criteria. For example, they may only be available in certain geographic areas, for certain business sectors, for specific types of people (for example, unemployed or young people), or for projects (such as marketing or buying IT equipment).
The National Enterprise Network is a network of independent local enterprise agencies in England. Go to www.nationalenterprisenetwork.org for a list of enterprise agencies.
The Prince's Trust
The Prince's Trust (www.princes-trust.org.uk) helps young people aged between 18 and 30, who are unemployed or under-employed, to start up in business. The trust aims to support disadvantaged young people who find it difficult to obtain finance from conventional sources. The trust operates from regional offices, arranging advice and training, as well as grants and loans.