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A Guide for SMEs Seeking Finance
With the alternative financing market experiencing huge growth, there’s never been a wider choice of options to fund your business. But do you know your crowd-funding from your business angels?
Our guide summarises some of the most popular ways businesses are funding their growth today and what’s behind the changes in the industry.
Why the rise in alternative financing?
Until fairly recently, the main option for businesses looking for financing was to secure a loan from a high street bank. Following the last recession, banks became less willing to lend businesses smaller sums due to the high transaction costs involved, so many small businesses were unable to get the financing they needed. This gap in the market has been quickly filled by alternative financing methods, thanks to developments in technology which make it easy to match borrowers with lenders.
How do I know which business finance option to choose?
An excellent place to start when weighing up your financing options is the government-owned, British Business Bank which was established to support small businesses. Their website has comprehensive guides for financing your business, whichever stage of growth it’s at.
There are two main types of financing and it’s likely that your business will need both at different points along its journey:
- Equity Financing - the raising of capital through the sale of shares in a business
- Debt Financing – the straightforward borrowing of money to be repaid under specific terms
Popular ways of financing businesses include:
Crowdfunding operates on the basis of asking a large number of people each for a small amount of money, usually through a crowdfunding website. The venture may involve investors each taking a small stake in the business (Equity Crowdfunding); receiving their money back with interest (Peer to Peer Lending) or simply donating money out of goodwill or to receive a small reward (Donation Crowdfunding). More details can be found on the UK Crowdfunding website.
If you’re familiar with the programme, Dragons’ Den, you’ll understand the Business Angels concept. Business Angels are individuals who back high risk business opportunities for high returns, either individually or through a syndicate. As well as providing business capital, they can help mentor your business. See https://www.ukbaa.org.uk for more information.
Venture Capital provides finance and operational expertise for entrepreneurs and start-ups, usually in technology-based sectors. Venture Capitalists will take minority stakes in businesses, often alongside other investors. They usually hold their investments for five to seven years, at which point the business is either floated on the stock exchange, bought by a larger organisation or the equity sold to another investor. Find out more at www.bvca.co.uk and www.venturecentral.co.uk.
Private Equity is similar to Venture Capital, but applies to mature businesses rather than start-ups. The investor offers medium to long term investment for equity in a potentially high growth business and works alongside the management team to enhance the value of the business. Typically, Private Equity firms hold investments for four to seven years. Find out more at www.bvca.co.uk.
Asset-based finance covers invoice financing and asset-based lending. Invoice financing involves generating money against unpaid invoices and is available to businesses that sell products or services on credit to other businesses. Asset-based lending offers finance against a wider pool of company assets including stock, property, machinery and even intellectual property. More information can be found at www.abfa.org.uk.
Merchant Cash Advance
A Merchant Cash Advance is available to businesses that take sales through a card terminal. It works by giving the business owner an upfront sum of money in exchange for a percentage of future sales through their card terminal. Repayments are set as a percentage of sales, so they go up and down in line with your business’s income at a level you’re comfortable with. The payments are taken at source, with the lender working directly with the card terminal provider. Unlike many other forms of financing, company or personal assets aren’t needed as security nor are credit checks necessary.
Choosing the right financial provider for your business
Unfortunately, not enough small businesses are aware of the diverse funding options available to them. According to British Business Bank, 71 percent of businesses seeking finance only speak to one lender and if they are refused, most don’t look elsewhere. If you’ve been refused a business loan from the traditional banks, the message is don’t give up. As Chancellor of the Exchequer, Philip Hammond stated: “A refusal from a big bank should not be the end of the line for a small business.”