Sources of Finance
“My most difficult class at Harvard Business School would have to be finance.” – Tyra Banks
You need to work out how you are going to finance your business and raise the funds to make a start.
Unless you have plenty of spare cash (in the experience of Yorkshire Powerhouse this is highly unlikely!) the odds are you will be looking to use a combination of personal investment from savings, family or friends and then seeking other investment – normally approaching funding providers and sources of finance that are commercially motivated. It’s well recognised that many institutional funders can be difficult to access when you are setting up, but a well defined business plan will give you the very best chance to persuade any potential funders to lend to you.
Raising finance from personal sources can come in numerous forms but most commonly from savings. Other assets that are regularly used could be things such as equity release, selling shares or money paid as part of a redundancy package.
Family funding (and friends) 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 or in the future, should anything go wrong. Not to do so would be reckless and could seriously damage your personal relationships in the future should the worst come to the worst. There should always be a written agreement, signed up to by all parties, which clearly states on what basis the money is provided. This could be a loan – interest free or confirming what rate of interest is to be charged and over what time period, shares or equity in the business and what percentage of ownership. If you’re really lucky, it may be gifted!
One of the key aspects to remember is that it is almost certain that commercial lenders or sources of finance such as a bank or private investor will want to see a personal financial commitment from you to give them the confidence and willingness to invest and take on the risk.
External sources of finance for a start up business can come in many forms and it can often be the case that there is a combination of funders who see joint support as a way of mitigating risk.
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 are potential sources of finances. The main sources of finance are best looked at individually:
- Banks – most peoples first port of call when they consider sources of 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 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. Additionally, it is not unusual to be asked to provide personal guarantees (PG’s) if you are borrowing money and these debts will then be secured against your personal assets.
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- 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 can be considered as sources of finance 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 work with. 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). This is where you purchase machinery or equipment for the business and pay for it over a period of time before you own the asset outright. You will obviously have to pay interest but it allows the business to buy 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 (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 includes tax advantages. It is certainly worth the effort to research and speak to providers if it is relevant to what you are doing.
- Remortgaging – when considering sources of finance, this option carries higher personal risk and is dependent on the agreement of 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. 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 will normally have an exit strategy) but basically they are speculating on your success. The business plan for an investor tends to need much greater detail and in-depth analysis of the venture. Individual investors tend to be interested in areas or sectors of business they are familiar with. The can often add value through greater involvement but 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 away and whether it helps you achieve what you want.
- 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 a 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 and that can be paid for over a period without interest, it is worth considering. Always understand the terms and conditions that apply.
- Crowd-funding – a relatively new kid on the block but it is an extremely viable option for start ups looking for sources of finance. 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 crowd-funding 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 available these days (in our opinion about as common as hens teeth!) but very useful if you can find a fund within whose criteria you fit. Grants are money which is provided from government sources that are designed to stimulate certain types of commercial activity and it doesn’t have to be paid back. They are normally dependent on 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. It is also normal that any grant awarded is subject to other funding also being injected into the business with the specific ratios varying per grant. 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!
- 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.
With all the options of sources of finance available to you, make sure you FULLY understand your obligations, responsibilities and liabilities in regard to any funding you agree or sign up to.
Whilst we are very much 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. This is something all commercial sources of finance will consider when balancing risk.
You have multiple sources of finance, some are more favourable than others. Assess your current circumstances and seek expert advice before committing.