The pros and cons of business borrowing

Explore the pros and cons of the different funding options available for your business with this interactive guide from AXA Business Insurance.

https://www.axa.co.uk/components/businessfunding/images/AXA_Facebook_business.jpg

The Pros&Cons of Business Funding

Which type of funding could work for you? Click below to find out

  • Family & Friends
  • Government Grants & Investment Schemes
  • Overdrafts, Bank Loans & Credit Cards
  • Enterprise zones
  • Crowdfunding
  • Personal Savings
  • Angel Investors
  • Family & Friends
  • Government Grants & Investment Schemes
  • Overdrafts, Bank Loans & Credit Cards
  • Enterprise zones
  • Crowdfunding
  • Personal Savings
  • Angel Investors

Find out more below in our guide to small business funding methods

Government grants and investment schemes

There's funding available from the government – but it seems not many businesses know what it is or how to get it.

  • Less than 20% of SMEs understand government initiatives like Enterprise Investment Schemes or Seed Enterprise Investment Schemes
  • 6% of businesses have actually made use of them
  • Just 5% of SMEs have made use of Funding for Lending
  • 7% have taken advantage of government loans
  • 70% of SMEs have no awareness of initiatives like Growth Accelerator and growth incubators
  • 33% don't know what an Enterprise Zone is

Source: AXA Business Insurance Research , May 2014

We've put together this brief outline of government initiatives designed to help SMEs, with links you can follow to find out more or to start your application process.

  • Enterprise Investment Schemes are designed for smaller, high-risk trading companies. They help to raise finance by offering investors a range of tax reliefs, provided qualifying conditions are met.
  • Seed Enterprise Investment Schemes are designed for small, early-stage companies. They also help encourage investment by offering tax reliefs to individual investors who buy new shares in those companies.
  • Funding for Lending is a government-backed initiative from the Bank of England. It provides funding to banks and building societies based on their lending performance, which in turn encourages them to lower interest rates and increase access to credit. Ask your bank about their involvement.
  • Growth Accelerator pairs businesses with expert coaches in three different areas Access to Finance, Business Development or Growth through Innovation . The Access to Finance function has already helped businesses raise more than £100m of external funding.
  • Growth incubators help speed up the growth of start-up companies and get early-stage businesses on the road to commercial success. Some are government funded, others are run by the private or education sectors.
  • Enterprise Zones or Areas have been set up by the UK, Scottish and Welsh governments. A pilot Enterprise Zone was established in Northern Ireland in March 2014. These zones all offer similar benefits, like business rate discounts, simplified planning processes and enhanced capital allowances.

Overdrafts, bank loans and credit cards

Almost half (45%) of the UK's SMEs use credit cards or overdrafts to cover shortfalls in income1. They're readily available and relatively quick to access or secure. But it's important to remember there are other solutions available. Of the 45% mentioned above:

  • 24% of the SMEs used credit cards to make up a shortfall
  • 27% used their overdraft
  • A further 20% used a bank loan

Where the shortfall is comparatively small, and the business is sure it can repay the debt quickly, credit cards or overdrafts may be the right solution. But consistently using those methods to deal with longer-term issues or larger amounts could be counter-productive.

Compared to the other funding options available, credit cards and overdrafts have very high interest rates. So in the longer term, businesses could end up paying significantly more than they would through an alternative method.

Similarly, a generic bank loan could carry much higher interest rates than, for example, a loan taken out through the Funding for Lending initiative. So it's well worth talking to participating banks before making an application. Depending how much you're borrowing and for how long, it could save you a lot of money in the long run.

The bottom line is that financing issues need to be addressed using the most cost-efficient solution available - one that effectively manages or solves the problem.

1Source: AXA Business Insurance Research , October 2014

Family and friends

On one hand, borrowing from family and friends is usually simple, quick and cheap – if not free. On the other hand, being in debt to someone you're close to can make for uncomfortable social or family situations.

When it comes to financing business, almost 18% of SMEs still go to the people they're closest to for help1. It's an understandably attractive idea. You're doing business with people you trust. You'll usually have quick access to the cash, without the need for lengthy applications and approvals.

Interest rates – if there are any at all – are likely to be extremely low. And when it comes to repayment, the Bank of Mum and Dad is likely to be far more flexible than other, more conventional financial institutions. On top of which, there are no ties to any particular lender or investor, so your business remains 100% your own.

If this is an option you're considering, there are a few simple things you can do to protect both yourself and the person you're borrowing from:

  • Have a frank discussion with the prospective lender before you take their cash – make sure they understand why you need it, how you'll use it, how you'll pay it back and any risks involved
  • Think it through – what if the business doesn't do well? How will that affect the people you're borrowing from? Being in debt is stressful. Being in debt to people you care about can be even more so
  • Get some professional advice – draw up a proper contract that covers the amount, the repayment period and the obligations on both lender and borrower
  • Have someone witness the agreement to protect both parties
  • Have a contingency plan in place in case of financial emergencies

Stick with those and you'll keep your financial relationship separate from your friends and family relationships. And that might be best for everyone.

1Source: AXA Business Insurance Research , October 2014

Angel investors

It seems there are a lot of businesses that don't understand the term 'angel investor'. During 2013, we asked British SMEs whether they had accessed business funding over the previous six months. Of those who had, less than 5% had received angel funding1.

That could be related to the fact that only 12.5% actually understood what angel funding is. Considering how many people watch Dragons' Den, that's a very low number. Because that's essentially what angel funding boils down to. An investor gives you the cash you need and gets a share of your business in turn.

There's more to it, of course. You don't just take the money and run. As well as shares in your business, the angel (or angels) will probably also want representation on the management team or board. That means you don't simply get the money, you also get the benefit of their experience, knowledge, contacts and mentoring as your business grows.

Here's how to identify an angel:

  • As a general guideline, individual angels will invest from £5,000 to £150,000, depending on the project
  • Syndicates of angels may be prepared to offer considerably higher amounts
  • Syndicates might be formed to support a single project, or as an ongoing arrangement
  • Angel investors should be self-certified as high net worth or sophisticated investors as defined by the Financial Services and Markets Act 2000
  • Angels will consider the people as well as the project before making a deal
  • According to independent start-up resource website startups.co.uk, most angels will expect a return of between two and 40 times their investment in anything from three to eight years

So how do you find and approach angel investors? There are a number of routes. You could start with industry organisations like the UK Business Angels Association or programmes like Growth Accelerator. Live pitching or showcasing events offer face to face contact and – of course – there are plenty to be found online.

You'll need a few basic tools. A well-crafted, realistic and thoroughly thought out business plan. An executive summary of that plan – angels get a lot of approaches and they don't want to wade through dozens of plans at once. A strong investment proposition. And a thorough understanding of your business, your sector and where you want to go.

1Source: AXA Business Insurance Research, May 2014

Enterprise Zones

Are you operating from an Enterprise Zone? You might well be, and just not realise it. A third of British SMEs have no idea what an Enterprise Zone is1, and they could be missing out on a range of benefits as a result.

There are 24 zones in England, 15 in Scotland (where they're called Enterprise Areas), seven in Wales and a pilot zone in Northern Ireland. Each offers broadly similar benefits to the companies located in them:

  • Up to 100% discount on business rates
  • Easier planning applications
  • Enhanced tax relief
  • Operating in a community of peers – by sector or simply in terms of entrepreneurial activity

Some of the benefits vary by area. In Scotland and England, for example, the government is pushing for the rollout of superfast broadband in Enterprise Zones. The Welsh Government offers competitive finance packages.

Scotland's Enterprise Areas are designated by sector, rather than location. So its four enterprise areas are Life Sciences, Low Carbon/Renewables (North), Low Carbon/Renewables (East) and General Manufacturing/Growth Sectors. Each area is represented in strategic locations across the country.

So how do you know if you're in an Enterprise Zone? Simple – just click below:

  • Locations in England
  • Locations in Scotland
  • Locations in Wales
  • Coleraine is the only location in Northern Ireland for the moment

If you are operating in an Enterprise Zone or Area, and you weren't previously aware of it, or if you're thinking of setting up in one of the relevant areas, you'll find more information from:

1Source: AXA Business Insurance Research , May 2014

Crowdfunding

It used to be said that it's not what you know, but who you know. Nowadays, it's more like it's not who you know, but who you can reach online.

Crowdfunding is like the social media of the business finance world. It's done online, it tries to reach as many people as possible and there are new ways to do it being developed all the time.

Only about a fifth of UK SMEs know what crowdfunding is – which isn't that surprising, it's still a relatively new phenomenon. Less than 10% of businesses have used it as a fundraising method.1

Its youth as a funding vehicle means it's still evolving, which in turn means there are few hard and fast rules for potential crowdfunders. The Financial Conduct Authority, however, does have some influence. It regulates:

  • Loan-based crowdfunding (also known as peer-to-peer lending), where consumers lend money in return for interest payments and repayment of capital over time.
  • Investment-based crowdfunding, where consumers invest directly or indirectly in new or established businesses by buying shares or debentures.

It does not regulate:

  • Donation-based crowdfunding, or people giving money to enterprises or organisations they want to support.
  • Pre-payment or rewards-based crowdfunding, where people give money in return for a reward, service or product.

If you're considering crowdfunding as a vehicle for your own financial needs, there are places that can help you find your feet. Crowdcube is one of the largest online platforms. It's a good place to find out more about how the system works, and how you can get involved. But there are other platforms available. Some might suit your sector. Some might suit your location. So it's worth browsing thoroughly before selecting the one you want to use.

1Source: AXA Business Insurance Research, May 2014

Personal savings

You've got a great business idea. Or a brilliant plan for growth. And there's money in your personal savings account that could help you achieve it. Should you make use of it?

Half of Britain's SMEs don't have any company savings to speak of. In October 2014 we researched how businesses were dealing with their finance needs. The results showed that 24% had savings of less than £5,000, while 26% had savings of less than £1,000.1

So for many, raiding the personal piggy bank is a tempting option – and an obvious one. It doesn't involve going into debt, you've only got yourself to pay back. It doesn't tie you down to any institution or individual. There's no interest rate. And the money's right there, ready to use.

However:

  • As always, there's risk involved – if the business starts to struggle or has a temporary cash flow problem, you have no savings to fall back on
  • You could lose your money altogether – there's no guarantee your plans will work out and you'll be left with nothing
  • It could impact your family relationships – so make sure your fellow savers are in complete agreement with your plans

The alternative to using existing savings is to start creating a new fund to meet business targets. There are loads of ways to save, like business banking savings accounts, business saving bonds, and tax-efficient funds like Cash ISAs or NISAs. You'll find great advice on sites like Money Saving Expert or Moneyfacts, or from your bank or independent financial adviser.

All forms of money raising, just like all forms of investment, carry some form of risk. The key thing is to make sure you've considered all the angles and all the options before you make a decision. That way you're prepared for almost any outcome.

1Source: AXA Business Insurance Research , October 2014.

Follow these links to find out more about small business insurance:

AXA Business Insurance and AXA Business Insurance Wizard.

Source: AXA's survey of small businesses was conducted in three waves: in October 2013 (sample size: 300 small businesses), April 2014 (sample size: 500 small businesses) and August 2014 (sample size: 350 small businesses). All respondents were sole traders or had fewer than nine employees, fitting the government definition of a 'small business'.