How to fund a small business

Self-funding for small businesses

One way to find money to get your business started or keep it afloat is to look to your own network and use either personal funds or borrow money from friends or family. Every funding method has benefits and risks, so let’s explore those in more depth.

Personal funds

If you’re looking for money, your own savings account may be the place to start. In fact, according to our recent report, 49% of small business owners use their own funds to support their business. And this makes some sense because if you’re not willing to put your own money behind the idea, how can you convince anyone else to? While this is an obvious source, you need to be careful when using it. Make sure that you’ve protected assets such as your house or retirement money and have a clear plan for when you need to stop tapping your personal finances to help the business. One way to help keep everything neat is to have a separate business bank account and business credit score – that way you’re not accidentally drawing too much from your personal funds to support your business.

Family and friends

You’ve likely talked about your business idea with your family and friends quite a lot. While some may seem only politely interested, others may be genuinely enthusiastic about the idea. If any of them are interested in investing in the business, that could help you raise some much-needed funds. For UK small business owners, this is actually the second biggest source of funding after personal funds with 22% tapping family to help out. If you’re looking to take this route, be sure to formalise the agreement even if it feels odd to be that structured with people you are close to. Ultimately, it helps protect both of you should there be any disagreements down the line.

Your agreement should cover things like how much money is being lent, whether this is a loan, a gift or an investment, what the repayment period is, whether or not there’s any interest being paid, and any other expectations either party may have. If you’re unsure how to draw up the agreement, consider consulting a professional to help you.

Investors for small businesses

If you or your personal network aren’t able to help support your business, then you can go for a more formal investor arrangement but you better be prepared to pitch frequently! There are many different ways that people can become an investor in your company – take a look at a few of the options available to you:

Venture capitalists

Generally, venture capitalists (VC) invest in slightly more mature businesses, so if you’re still in the start up phase you may not have much luck with this avenue. However, if you’re a more established business looking to scale up and have a proven business success, then venture capitalists may be a good choice for you. This seems to be an especially popular funding route with younger business owners as our report showed that 59% of 18 – 24-year-old business owners were looking to venture capital as a place for funding. VCs often take a sizable stake in the business (think 20% or more) in return for their investment and will expect to get back that initial cash plus profits. To attract VCs, you’ll need to have a compelling demonstration of the return on investment they can expect to see and you’ll want to look for one who has some knowledge or experience in your business sector. You may work with a VC firm that oversees a pool of money from many investors rather than just one specific investor.

Angel investors

Angel investors typically have personal wealth and want to use that to financially back small startups. Whereas VCs wait until a business is more established, angel investors often come in at an earlier stage to help a business get on their feet. Both the investment and the stake they take in the business tends to be lower than what you might receive from a venture capitalist because it tends to be a riskier investment if the business isn’t well proven yet. If you go down this route, make sure that you and your angel have the same vision for the business, and that there’s a good personal fit. While losing control is a valid concern, expert support could be just as important as cash flow when it comes to business success – so it’s worth weighing up.

Crowdfunding

The major players include Crowdcube and Kickstarter, although they have quite distinct models: Crowdcube allows you to offer an equity stake in your business in exchange for investment, while Kickstarter investors offer pledges in exchange for rewards. Both platforms stipulate that you can’t keep any of the investments pledged unless you meet your full funding goal.
While crowdfunding has plenty of advantages, it’s important to remember that your ideas aren’t automatically protected when you put your pitch online – so unless you have a watertight patent, you risk exposing your USP to competitors.

Small business loans

Loans are probably the first thing that comes to mind when considering financing – usually from the bank. However, it can be difficult to get a bank loan if you don’t have a good credit score or don’t have a long borrowing history. If you’re bank loans aren’t a route that’s going to work for you, here’s a few other loan types that you can explore:

Peer to peer/peer to business lending

The rise of peer-to-peer lenders like Funding Circle and RateSetter grew out of the recession. Often these can have a faster application process than other loan types and greater flexibility. Each borrower borrows small amounts from many different lenders to make up the full loan they need. The lending platform is paid sometimes a fee to connect you with these other small investors and the interest you pay goes back to those that helped fund you initially. Like a regular loan there are financial prerequisites, but the attraction is the availability of relatively low interest unsecured loans, the flexibility in the length of loan repayment terms and the speed with which the cash is released.

Guaranteed loans

In guaranteed loans, you are still responsible for repaying the principal amount and the interest, but you get a third party to agree to pay if you default on the loan. If you don’t have a strong credit history, finding a guarantor for you loan may help lenders feel more comfortable working with you. There are guaranteed loan schemes run by businesses and local governments but be sure to do your research before committing to any of these as there can be fraudulent schemes out there.

Asset refinancing

If you have a low credit score and are struggling to find a guarantor, asset refinancing is another route you can take to help a lender feel more comfortable lending to you. In asset refinancing, a business uses assets that they own as security against a loan. What this means is that you can have certain machinery, vehicles, or equipment used as collateral if you default on your loan. Often lenders will only give you a loan that is close to the value of the items you are using as security.

Funding for equipment purchases

Often the equipment you’ll need in order to do business can be very expensive and would require a lot of cash on hand to buy outright. If you’re struggling to raise that much cash immediately, there are a few options for funding these larger purchases over time.

Hire purchasing

Hire purchasing is a financing method that small business can use when they’re looking to buy equipment which allows you to put down an initial deposit and pay the rest in regular instalments. At the end of the payment agreement, you’ll own the equipment.

Leasing equipment

Another option for funding the purchase of much needed equipment for you startup is to lease it. When you lease equipment, you’ll often enter a contract with a lender to use the equipment for a set period of time. You then make fixed payments at regular intervals up until the contract ends. AT the end of the contract, you’ll often have the chance to return the equipment, upgrade to a newer model, extend the current lease, or buy the equipment.

Small business grants and other funding schemes

There are many organisations that support business growth whether through grants or competitions. Most often, grants are offered for specific sectors that help promote development and growth or specific hot button issues such as sustainability or employment for those in under privileged communities. These can be highly competitive and have strict criteria so be sure to research them carefully!

Government funded

The government has introduced a range of grants and business investment schemes designed to help SMEs. Often, government grants don't need to be paid back and don’t require giving up any equity – so, unsurprisingly, competition is intense and the application process is rigorous.

Government investment schemes, such as the Seed Enterprise Investment Scheme (SEIS) also help SMEs get access to funding by encouraging investors to put their money into small early-stage and high-risk businesses in exchange for tax relief.

Other grants

There are many small organisations that have grants for small businesses or businesses which are working in an area of interest for the lender. There are too many to list specific schemes here, but it’s worth researching what’s available in your industry or local area that may be able to help you. While grants tend to be small amounts of money, getting a few may help you get the cash you need to succeed.

Competitions

So, we all know Dragon’s Den however, there’s plenty of smaller scale competition that you can enter in order to get business funding. AXA’s Startup Angel is one great option to explore which gives businesses or business ideas a big cash injection when they’re just starting out – and the application process has been kept surprisingly simple to make it accessible for the business owner who is trying to do it all. This is just one example of many competitions available, so do your research to find the one that’s right for you!

Choosing the right option for your business

Unfortunately, that choice is solely up to you. Every option listed here has benefits and drawbacks and what works best will entirely depend on your business needs and situation. Having a strong business plan, accurate financial forecasts, and a good understanding of your cashflow may help you decide, but if you’re struggling to figure out the best option, it is always worthwhile to ask a financial advisor for their professional opinion.