Phil Mitchell, Partner, Harbour Key
In the economic downturn, securing new funds for your business was as difficult as tracking a polar bear in a snowstorm, especially for start-ups.
Despite the perceived upturn in the economy, bank lending to small and medium sized business is still in decline and there are no signs of the position changing. As a result, business owners have had to look at more innovative ways to fund and grow their business. While some options may only be appropriate for relatively new businesses, others will be suitable for more mature businesses either looking to fund growth or requiring emergency cash flow. As a start-up, your options are likely to be limited and initially the only option may be yourself or family.
Before looking for third party funding you should first be clear what it is required for e.g. more staff, premises, machinery, etc., how much this will cost and how it will improve profit and cash flow.
Once you have an idea of what you need, consider whether external finance is required at all, e.g. an established business may be able to fund itself by making improvements to cash flow.
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Cash is still king and a review of prices, costs, sales, stock levels, debtors etc. may show that managing cash flow more effectively will enable you to avoid the need for emergency funding.
If funding cannot be achieved internally or is not an option, the next step is to consider what choices you have and which of those would best suit the business. Funding can generally be divided in two categories: borrowing and capital investment. Borrowing means the business will have to service the debt and you may have to provide personal guarantees, whereas capital investment involves giving up part of your ownership.
Outside normal business loans and overdrafts, most of the main banks offer the Enterprise Finance Guarantee (EFG) loan; this is a government backed guarantee scheme to facilitate lending to viable businesses that have been turned down for a normal commercial loan due to a lack of either security or a proven trading record. Although welcome, in our experience businesses have had difficulties in getting banks to agree to EFG loans.
Other sources of borrowing include:
- Peer to peer lending – the practice of lending money to unrelated individuals, or “peers”, without going through a traditional financial intermediary such as a bank. The company “advertises” their business and loan proposition on a web-based platform to potential lenders, who indicate their interest and the amount they are prepared to lend. With low returns for savers, there has been an 80% growth in funds from investors seeking a better return.
- Working capital – linked to the above, these are online auctions of individual invoices or packages of invoices (this is a growing new form of funding that avoids the high cost of full debt factoring).
- Leasing assets/hire purchase – these provide an alternative to buying machinery or equipment. Some companies offer beneficial arrangements through organisations such as the Federation of Small Businesses, while others offer favourable terms e.g. BT gives start-ups favourable terms for a three year lease on telecoms/computer equipment.
- Debt factoring/invoicing discounting – although commercially different, both factoring and discounting are based on the principle of selling a business’s invoices to a third party. The third party is charged with processing the invoices, and the business can receive loans based on the expected invoice payments.
- Pensions – company pension schemes are not generally permitted to make loans to their sponsoring employer. One exception is the Small Self-Administered Scheme (SSAS), provided certain conditions are met. However, borrowing from your pension means your fund is at risk.
Lenders of last resort can be considered for small loans where the business has been refused by a bank. These are typically charities or regional/local council initiatives and can lend funds up to a limit of around £20,000. Interest is charged on the unsecured loan, generally slightly higher than a high street lender.
Short-term lenders such as Wonga now offer businesses short-term emergency loans to solve cash flow problems, but it is important to consider the interest rates and affordability.
For start-ups, personal loans of up to £25,000 can be obtained from the Government’s start-up loan initiative. The average granted is around £6,000.
Capital investment requires the business owner to give up part of their ownership (i.e. shares in a limited company or a capital share in a partnership) in exchange for a cash investment.
It is important for owners to understand that, in most cases, this may result in third parties being involved in running their business. This should be viewed as positive where, in addition to the cash, the investor brings useful skills, experience and contacts.
The main sources of capital investment are:
- Friends and family.
- Web-based crowd source funding, which can either be equity based (shares), the most common, or reward based (for example, percentage of future returns). Similar to peer to peer lending, it involves pitching your business on a web platform to attract investors.
- Accelerators – either government or privately backed programmes for young, high growth businesses, these generally provide some level of funding and support such as mentoring, office space and training.
- Business angels – usually wealthy individuals who have already made their fortune through other business ventures and may provide time and experience as well as money. They may invest on their own or as part of an angel network. Although there is no set limit, angel funding is typically in the £400k to £500k range. For larger investments, a venture capital company can be considered.
There are tax advantages for investors in making capital investments to limited companies under the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS). Each scheme has its own qualifying conditions, including the amount that can be invested and the type of trade the company conducts.
Grants normally relate to specific industry sectors or those businesses based in a particular region earmarked for development or regeneration. For example, the Technology Strategy Board is a government funded body that provides grants to bring new products and services to the market. Alternatively, your local council may offer small grants for improving your shop front or assisting with training.
Raising finance from an external source can provide a crucial launch pad when growing a business. When looking for funding, you need to consider all your options, how to apply for investment to maximise your chances of success, and whether you meet all the funding criteria.
About the author
Phil qualified as a solicitor and practised commercial law for five years before joining Grant Thornton in 2000 to specialise in tax. He moved to Edge Tax Consultancy as a senior adviser before co-founding Harbour Key LLP in 2011 to provide tax planning and advice to individuals and businesses. Phil is a Chartered Tax Advisor. www.harbourkey.com