Adequate funding is vital to operating a successful business. Without it, the day to day running of the organisation can be challenging making expansion difficult, if not impossible. There is an abundance of different types of business funding available, depending on your requirements, such as whether the additional money is needed for short-term working capital requirements, the long-term financing associated with acquisitions, or major capital investment for growth.
According to the British Business Bank Survey, 60 percent of SME businesses (up to 249 employees) sought some form of external funding in the last three years. The key to choosing the right funding is knowing exactly what it is needed for and when it is required.
What do you want to achieve?
Before funding and timescales can be considered, the end goal needs to be decided. After all, there is little need to raise finance if it isn’t funding anything or if the rationale isn’t clear. To do this, it is imperative that the business plan and growth projections are consulted.
Growth can take many forms and mean different things. For example, it could be:
– Expanding existing operations
– Opening a new store or premises
– Investing in a new product line
– Purchasing new assets such as IT equipment
– Setting up marketing and/or sales teams
A good business plan will detail the long-term goals, including things like when additional warehouses or manufacturing plants are forecast to be needed, and what the predicted cashflow is for the business at that exact point. This will further help inform the decision as to which type of funding will be required.
When is the funding needed?
Having a positive cashflow is critical to running a successful business, especially at the point of growth.
Once the objectives are clearly distinguished, it is then time to consider what type of funding is needed and how long it might take to secure it. Some sources will take a significant amount of time, whereas other forms won’t, so it’s important to understand which category the funding falls into.
Debt vs equity, an overview
There are two main finance options:
Debit finance whereby you borrow money that you have to pay back, usually with interest
Equity finance which works by selling a share of the business to generate funds, the investor usually realises a return when they then sell their shares at a future date
Below is a breakdown of the different types of finance:
Short term refers to finance that can be repaid in less than 1 year. Long term finance is typically repaid over 2 – 5 years or more than 5 years.
If a business is small, Government grants could be a great option because they won’t leave the business surrounded in debt. However, they do involve a lot of form filling and red tape, which can make for a lengthy process that may not fit into the expansion timeline.
The same can be said for venture capitalists. It can take time to find the right investor for a business and it is a decision not to be taken lightly, as more often than not they will also sit on the board and share part ownership of the company, so, it is important that they fit within the culture. However, what is gained in return is an experienced backer that will push the organisation in many different ways and ask questions which may have otherwise been overlooked.
Financing options which don’t have such long lead times include loans from family or friends and bank overdraft facilities. However, these are better suited to short-term funding needs rather than large investments.
Loaning money from friends or family means that banks don’t need to be approached and interest rates are generally lower. However, it is also an indicator that other investors aren’t showing interest in the business, which could mean the plan for the expansion isn’t robust enough.
Bank overdrafts are easy to arrange and are fairly flexible, with many businesses using them to dip into at times when cashflow may be stretched. The downside is that they often come with steep interest rates which will need to be factored into the overall costs and mean they aren’t ideal for extended periods of financial need.
Alternative, new options
Recent years have witnessed the rise of crowdsourcing funding either from your existing customer base in terms of direct investment bonds, or via the internet from ‘micro-Angels’. In the case of the later, these are small investors who are willing to back entrepreneurial businesses.
There are 4 types of crowd funding that act as an alternative to traditional financing. These include:
There is no material reward for an investor’s aid, a case of charity or philanthropy. An example platform includes GoFundMe.
These are crowdfunding projects that offer products or services in return for an investors support. Rewards will vary depending on the size of the investment. For example, the fast food chain Leon issued direct investment bonds and investors received vouchers to spend in the restaurant in return. Many organisations have made use of Kickstarter for this.
Investors receive equity or ownership in return for their financial contribution. Crowdcube is one of the more well known platforms for this.
Debt crowdfunding (or loan crowdfunding) allows businesses to borrow money from a group of people. Investors lend money to a company and receive interest from their investment. In theory businesses to get funded at lower interest rates through a quick and easy business loan. You then pay interest directly to the investors as opposed to an institution like a bank.
Accessing finance is an essential part of being able to grow a business successfully. It is therefore important that the decision of when and how to finance, is carefully considered as it can also impact the enterprise further down the line.
If the most suitable option is debt finance then further consideration is needed as to level of personal risk you’re willing to take. Many lenders, especially banks, will seek some form of personal guarantee or debenture. That’s likely to mean personal liability if you can’t settle the debt. Be sure you understand exactly how much you’re guaranteeing and when this will apply.
Carefully formulated plans will ensure that the influx of extra capital is sufficient to support the projected growth and any repayments will not hinder the day-to-day operations.
Businesses looking to fund the next stage of their business’ life cycle will also be interested in the Wellers guide on financing for SMEs download.