Types of Finance
“I believe that through knowledge and discipline, financial peace is possible for all of us.” – Dave Ramsey
The biggest issue most people face when starting a business is knowing how much money is needed to successfully start and sustain the venture and how to raise the funds.
- How much do you need before starting?
- How much do you need to launch?
- How much do you need to invest in machinery, stock etc?
- How much have you got or can afford to invest personally?
- Can you raise finance and how much do you need from external sources?
- What will the business need to generate to be sustainable and provide an acceptable income?
There are lots of questions but it’s something that requires very careful consideration.
As you would expect, start up businesses are classed as high risk areas for funders and its no surprise that a robust business plan is vital to get “buy in” from organisations which provide the types of finance you may be seeking. The main types of finance are best looked at individually –
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- Personal Funding – Raising finance from personal sources can come in numerous forms but most commonly from savings. Family (and friends) funding is also common but there are some golden rules around how you do this to ensure everybody fully understands the basis on which the money is provided. Family (particularly parents) have a vested interest in seeing you do well and can be willing participants in supporting your venture. You have a responsibility to make sure that they are not investing money that could put them in difficult position, both now and in the future, should anything go wrong.
- Banks – most peoples first port of call when they consider finance for a business start up. It is always worthwhile engaging with them asap and certainly before you have spent any of your personal investment in the business. Most banks have start up business banking offers and they can provide loans, overdraft facilities and credit cards as options to allow you to access finance. They will scrutinise your business plan in some detail and you have to be prepared to undergo a rigorous process to achieve a successful outcome. In addition, it is not unusual to be asked to provide personal guarantees (PG’s) if you are borrowing money and these will be secured against your personal assets. Obviously you need to understand the implications of this!
- Other funders – there are many business support organisations who can offer a wide range of loans outside banks. Enterprise agencies, local authorities, government backed schemes and Chambers of Commerce are all examples of organisations who could potentially have loans funds and many are specifically to support start up businesses. They can often be what is called “lenders of last resort” and this often means you will pay slightly more interest but as they are tailored to operating in a higher risk area of business finance, they can be much more “user friendly” to start up entrepreneurs. Never the less, their due diligence will still require you to provide a well constructed business plan that shows the viability of your venture.
- Specialist funders – this relates mainly to areas around specialist asset finance providers (banks can also provide this) where you purchase machinery or equipment for the business and pay for it over a period of time before you own the asset. With these types of finance, you will pay interest but it allows the business to buy what are often expensive items without the high cost of outright purchase. The funding is secured against the asset being purchased. This can also include leasing where you don’t ever own the asset but pay to utilise it over a fixed period as agreed (vehicles being a common one) for a monthly or annual payment. Although it’s not always easy for a new business to access this kind of funding, it can be very beneficial and often have tax advantages. It is certainly worth the effort to research and speak to providers if it is relevant to what you are doing.
- Suppliers – similar to specialist funders above. Many suppliers of anything from your office furniture and equipment to heavy machinery can offer you their own asset based finance. Again, research to see what you can find.
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- Credit cards – whilst it is never recommended that you run your business through personal finance and banking facilities, the availability of personal credit and the many attractive deals on credit cards can provide a viable source of funding for a start up. It should only be considered as relatively short term option (dependent on offers available and over the critical first 12 – 18 months of the new business) and without being reckless. If there is an opportunity to purchase something that is needed for the business that can be paid for over a period without interest, it is certainly worth considering. Always understand the terms and conditions that apply – especially to the high interest rates applied to credit cards.
- Remortgaging – as types of finance go, this is a much higher level of personal risk and is obviously dependent on your mortgage provider but this could be a viable alternative to more conventional areas of funding. The cost can be more attractive and paying it back can be spread over a longer period of time.
- Investors – they will look for a share and take equity in your business in return for the finance provided. They can be organisations or individuals but their motives are somewhat different to other funders. Equity based investment shouldn’t be something to be afraid of – it can often be the springboard to rapid success for the business and can to be considered. You could potentially achieve something in a much shorter time with an investor that may take you years without. They will want a return on their money and have an exit strategy in place but basically they are speculating on your success. The plan for an investor tends to need much greater detail and in-depth analysis of the venture. Individual investors tend to be interested in with areas of business they are familiar with and often like to add value through greater involvement but individual or organisational, they will want some representation in your business. There are investors who specialise in start ups but the main thing is that you fully understand the implications of taking on an investor and be aware of what you give and does it help you achieve what you want.
- Crowdfunding – a relatively new kid on the block as types of finance go, but it is an extremely viable option for start ups. It is basically equity investment but spread over numerous investors (the crowd!) who tend to invest smaller amounts in businesses that attract them not purely for high financial returns (although they do hope for a return) but for more emotive reasons. This is becoming increasingly popular and there are a number of online platforms available through which you can access crowdfunding and have your portfolio of investors managed for you. It is imperative that you research these thoroughly to ensure legality and that their criteria fit within what you want for the business and any future implications.
- Grants – less availability these days but very useful if you can find a grant funder within whose criteria you fit. Grants are money which is provided from government type sources that are designed to stimulate certain types of commercial activity and it doesn’t have to be paid back. This could be job creation, business growth or investment in new or environmental technology but they are all linked to things which promote successful businesses. There will invariably be an application process and it can vary greatly in the depth and detail required. The key thing is to ensure you fit the criteria for the grant you have identified – too many times people try to make the business fit the grant rather than the other way round and this can cost you a very precious commodity – time!
With all the different types of finance available, make sure you FULLY understand your obligations, responsibilities and liabilities in regard to any funding you agree or sign up to. Whilst we are generally talking about success with a new venture, there is still a degree of risk and you need to be aware of the implications should things not go to plan.