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Financing your business

Introduction
Every new business needs money when starting up. For the majority of businesses, equipment will need to be bought, the workplace established and marketing costs met - all before the first sale is made. Then once you're trading, you'll need cash to pay the bills and keep the business going.

There is a range of financing options. Choosing the right ones for your needs is essential. You can use your own money, borrow from banks, family and friends or attract outside investors. Grants and government support may also be available.

Most businesses use a combination of these, tailored to their specific needs and circumstances.

This guide looks at how to work out how much money you need, the best financing options for your business and their advantages and disadvantages.

Work out your financial requirements
When starting your business, you need to put together a business plan. This plan sets out how you intend to operate your business and includes essential financial forecasts. These forecasts will help you determine how much funding the business is likely to need, what you need it for and when you will need the money.

Good planning will also make it easier to raise the money you need. Use your business plan to explain your business to your bank and other potential sources of finance. A good plan helps convince them that you know what you are doing, and that it is worth risking their money backing you.

How much will you need - and when?
It's essential to have an accurate idea of your financial needs. Once you've calculated the amount you'll need to cover your initial start-up costs, you'll also need to factor in your running expenses. Customers may not pay you immediately - but you will still need to pay all your bills to keep trading. It's sensible to have sufficient capital to cover projected expenses for at least six months.

Consider your own needs
At the same time, you need to make sure that you have taken into account how much money you need to live on. In the early stages, a new business is unlikely to produce spare cash that you can spend on yourself.

Choose the best financial option
The type of finance you choose will depend on what kind of business you are starting, how much money you need and what you will use it for.

• Many people use their own savings or personal borrowings to fund the business. This may be the only choice if you can't convince anyone else to lend you money or invest in the business.
• Family or friends might back you. However you should carefully consider the risk that they could lose their money if your business fails
• If you can put up some finance yourself, and have a credible business plan, you may be able to borrow from a bank. Many businesses use overdrafts for day-to-day borrowing and loans to finance large purchases such as equipment. If your business is likely to have peaks and troughs in its cashflow, it's essential to be able to clearly illustrate these to your bank so you can plan an overdraft
• A larger business with good prospects might attract outside investors. For example, "business angels" typically invest £10,000 or more in exchange for a share in the business
• You might qualify for a grant - for example, if you are setting up a business in a deprived area.

Most businesses use a mixture of finance sources. For example, you might invest your own money in market research, bring in outside investors to share the risk and borrow from the bank to purchase equipment and machinery.

Use your own money to set up your business
If you're starting a new business, it's likely that you'll have to put up some of the money yourself. In fact, it's usually difficult to borrow from a bank or attract other investors unless you're investing some of your own money.

The easiest way to provide your own financing is if you have savings you can use. If not, you'll have to think about other possibilities, such as:

• getting a mortgage, or second mortgage
• borrowing privately
• getting an unsecured loan, or borrowing on credit cards
• selling possessions or assets

You should think carefully before borrowing to finance your business and should match the financing to your needs. For example, using credit cards for long-term expenditure can be cripplingly expensive while some loans can be inflexible - you could end up paying interest over many years.

Don't over-extend yourself. If you borrow too much, you may not have enough money left to cover your living costs while the business gets going. You should also try to leave a contingency fund, in case you need extra money to see you through a difficult period.

Advantages
Self-financing your business gives you far more control than other finance options. Outside investors or lenders could decide to withdraw their support at any time and most will expect a good return on their investment in the form of interest, shares or dividends.

Disadvantages
You must be aware of the risks. If your business fails you could lose your home and other personal possessions. And just knowing how much you have borrowed can put a lot of pressure on you and your family.

Use finance from friends and family
If you can't raise enough money yourself to start your new business, your friends and family may be willing to help. They might lend money to you or to your new business or they might invest in your business, eg by buying shares.

You should provide potential investors with an up-to-date business plan. It will help demonstrate how their money will be used and explains the long-term plans for the business. You should also make sure that you have a written agreement in place that sets out terms and conditions, including any interest and repayment terms. This should help avoid misunderstandings.

There may also be tax implications for you and your family, especially on interest-bearing loans
Advantages

• Friends or family may be more willing to lend you money than a bank, particularly if you cannot provide security for a loan.
• Friends and family may offer easy terms - eg an interest-free loan.
• If you can raise some finance from your own resources or friends and family, it should make it easier to get additional finance from the bank.

Disadvantages
You need to be careful. You may feel under personal pressure, particularly if your business starts to struggle and there's a risk that friends or family will lose their money. Remember that they too may worry about their money and this may put a significant strain on your relationship.

As a rule of thumb, you should never ask them to lend you more than they can afford to lose. You should also seriously reconsider whether your business is a viable prospect if traditional lenders such as banks are unwilling to lend you money to start up.

It is wise for both sides to take professional advice before proceeding with any agreement. You should consult your financial adviser or solicitor.

Use bank finance to start your business
Overdrafts and bank loans are the most common sources of additional finance.
Before lending, a bank will want to know that you are a good risk. Typically, the bank will want you to:

• present a credible business plan
• provide evidence that you have a successful track record in business
• offer security for any money it lends you - either business assets or a personal guarantee
• invest some money in the business yourself

If you don't meet all the bank's normal requirements, you may qualify for a loan under the government's Small Firms Loan Guarantee (SFLG) scheme.

Whatever type of borrowing you use, you may have to pay arrangement fees as well as interest.

Many small businesses use an overdraft to cover their borrowing needs. If you need longer term financing, it's a good idea to consider taking out a loan.

	Borrowing method	Advantages	Disadvantages
Overdraft	a flexible way of funding your day-to-day financial requirements interest is only payable on the amount you are overdrawn	higher interest rates than loans leaves you with no contingency funds if you are regularly overdrawn bank can ask for repayment at any time
Loan	you can match the term of a loan to your requirements easier to budget for repayments	no flexibility - you could be paying interest on funds you are not using regular payments could cause cashflow problems you may have to offer some form of security

Always take advice from your accountant or business adviser before signing any agreement to ensure the loan meets your requirements and you understand the terms.

Get outside investors to help finance your business
You might want to bring in outside investors. If the business does well, they share in the profits - but if the business fails, they lose their money.

Typically, your company issues ordinary shares (standard shares with no special rights or restrictions) to investors in return for their investment.

Outside investment can suit promising businesses that do not expect to produce a lot of spare cash in the short term but offer the potential of greater returns over the longer term.

Advantages

• Attractive for businesses looking to bring in additional expertise as well as funding.
• Unlike loans and overdrafts, you do not normally have to make payments to investors until the business can afford them.
• Increasing the capital invested in the business makes it easier to borrow from the bank.

Disadvantages

• Your share of the business, and of its profits, will be lower.
• Investors may want control over how you manage the business.
• Investors may want the business structured in a way that makes it easier to sell their shares in the future.

Sources of investment
There are several different sources of investment:

• individuals, such as friends and business contacts
• business angels
• investment funds and venture capitalists for larger investments

Business angels are wealthy individuals who typically invest £10,000 upwards and may also offer business expertise. Venture capitalists usually invest more than £2 million in businesses they believe will provide a high earning potential and a defined exit time.

Before approaching potential investors you need a good business plan, including evidence of your management ability. Your plan should include detailed financial forecasts and demonstrate what you will do with funds invested in the business. You will also need to prepare a pitch, which will sell your business to potential investors.

Government Grant
A grant is a sum of money given to an individual or business for a specific project or purpose.

A grant usually covers only part of the total costs involved. However, as long as you keep to any conditions attached to the grant, you will not have to repay it or give up shares in your business.

Grants to help with business development are available from a variety of sources, such as the government, European Union, Regional Development Agencies, Business Link, local authorities and some charitable organisations.

These grants may be linked to business activity or a specific industry sector. Some grants are linked to specific geographical areas, eg those in need of economic regeneration.

This guide introduces you to some of the grants available to businesses in the UK, and outlines the kinds of projects and organisations they are available to. It also provides hints on improving your chances of being awarded a grant.


Government Grant and Support
The government provides support to businesses both financially, in the form of grants, and through access to networks of expert advice and information.

However, getting financial support can be tough. There will be strong competition, and the criteria for awards are stringent. These vary but are likely to include the location, size and industry sector of the business. Government grants are almost always awarded for a specific purpose or project and are usually for proposed projects only - not for those that have already started.

There are also strict terms and conditions that apply to all grants. If these aren't followed, immediate repayment of the grant can be required. However, generally you do not have to repay grants or interest on them unless you break the conditions.

Matching grant funds
Most government grants require you to match the funds you are being awarded. In other words, the grant covers a proportion of the money needed, while you supply the rest. You must also demonstrate that your business can provide its share of the total costs.

The amount of matching funds asked for varies from grant to grant. A research grant may require a business to find only 40 per cent of the total cost with 60 per cent provided by the grant. However, a grant to refurbish a factory may provide considerably less.

The matching funds may be found from the owners of the business, retained profits, a loan, or from a new investor.

The main groups who award grants are:

• the government
• the European Union
• Regional Development Agencies in England, Scottish Enterprise, the Welsh Development Agency and Invest Northern Ireland
• local authorities or local councils and local development agencies
• Business Links
• Chambers of Commerce
• County Enterprise Boards
• Some funding is also distributed through colleges and the Learning and Skills Council (LSC).

Grant eligibility
There are a number of factors which could affect your eligibility for grants.

Location of your business
Each of the countries of the UK has its own range of grants available. Some areas get extra grants, for example because of social deprivation or high unemployment.

Some grants are also given by local authorities to help local businesses.

Size of your business
You may only be eligible for some grants if your business is of a particular size, measured either by turnover or the number of employees.

Many grants are limited to small or medium-sized enterprises - typically those with fewer than 250 employees.

Your industry sector
Funding can be limited and subject to restrictions in certain sectors defined by the European Commission. Any applications that are made for grants will be closely inspected by the Commission.

The purpose of the grant
Grants are often awarded for a specific purpose such as purchasing machinery, improving offices or developing export markets.

Grant bodies prefer to see specific targets and results - often compatible with their own objectives.

As well as making an assessment of the benefits of your project, the awarding body will expect a high level of commitment from you and your business, and for the project to be commercially viable.

Whether you are eligible for a grant will depend on the terms and conditions of the specific grant applied for.

How to apply for a government grant
Before you apply for a grant you should make sure that you meet the conditions of the scheme. Additionally, you should ensure that you:

• are ready to put up some of your own money
• need the money for a specific purpose
• don't start the project before you get an agreement in principle of funding

Once you are ready to apply for a grant, you can give yourself a better chance of applying for and being awarded the right grant by talking to an adviser at your local Business Link. They will help you to identify appropriate European, national and local grants, including contacting the person who administers the grant to check your suitability and to make sure that the grant scheme is still running. Find your local Business Link through our Contacts Directory.

Making your proposal
When you have identified the right grant scheme for your needs, you will have to provide:

• a detailed project description
• an explanation of the potential benefits of the project
• a detailed work plan with full costings
• details of your own relevant experience and that of other key managers
• completed application forms where stipulated
• possibly a business plan

Some businesses get advice from their accountant, who can also help in drawing up an effective business plan. Remember to submit your application before the deadline where relevant - late applications are rarely considered.

Most reviewers will assess your proposal by using the following criteria:

• significance
• approach
• innovation
• their assessment of your expertise
• need for the grant

Be prepared to wait for anything from a few weeks to a year for a decision. Local applications are typically processed much more quickly than others.


Source: www.businesslink.gov.uk