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Should I use a bank loan or investment to launch my business?

Is debt or equity finance the best fit for your business? Here are some key points to consider

I need to raise £20,000 to get my business off the ground and have been advised to go down the bank loan route as opposed to giving up equity. Is it better to stick with loans for relatively low amounts of investment, or would an angel or private equity firm have more to offer?

Sam Gyimah writes:

£20,000 is not a lot of money to launch a business with so the first issue to address is where it gets you in terms of the development of the business. If you’re launching a product there is always the risk that it takes longer to get to market. If you are launching a service, you may not sign up your first client when you expect or they may not pay you on time, and it can be difficult to raise further cash mid-way through your project.

Once you’ve decided how much you need to raise you will be in a better position to evaluate which sources of funding suit your business.   

In general, bank debt is the most attractive option to many entrepreneurs as it enables them to keep 100% equity and control of the business.However, banks don’t often lend against start-up business ideas especially since this requires taking equity style risk.

There are other loan products such as invoice discounting or factoring, which allow you to borrow against receivables in your business which you could take advantage of depending on your business model. Most banks have a commercial banking arm responsible for these products.

If you have a solid contract from a blue chip client, you might be able to persuade your bank to lend against the value of that contract. Alternatively, you could try persuading your client to pay a portion of the fee upfront, which could help fund your business – although this is not always easy.

However, getting professional business angels or private equity firms to invest in an early stage venture is not easy either. Ideally, you should have a credible management team in place and a well-researched business plan capable of withstanding the scrutiny of an impartial and hard-nosed investor. 

Be prepared to give up control and a significant slice of the equity to reflect the risk profile of the business. The earlier the stage of the business, the more risky! Depending on your ambition for your business and its cashflow dynamics, private equity backing, especially given the endorsement value and contacts it can bring, can make a real difference. The key question is determining the right time to seek such backing.

If you’re happy to welcome the risk into your home, there’s always the option of borrowing against the value of your property. Tapping friends and family might also be a good place to start. This tends to be quicker, possibly cheaper (depending on what your friends are like) and easier to come by. But any such investment obviously comes with its own strings attached.

Ultimately, it’s not just the cash that determines the success of your enterprise. The quality of the people you have on board is more important. So if you are raising cash, always try to raise it from people who can provide more than just a cheque. 

Sam Gyimah, is chief executive officer of Workology.com , and was named CBI Entrepreneur of the Future 2005. He’s also one of the British Library Business & IP Centre’s business experts, offering free one-to-one advisory sessions. To apply for a place visit  http://www.bl.uk/bipc/ask.html

Got a question for one of our experts to answer? Send it to sarar@crimsonbusiness.co.uk

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