Explore how to make the most of small business finance to fuel your growth ambitions
There are a multitude of sources of business finance available to help small businesses achieve their growth ambitions.
But deciding which small business financing option is right for you, and how you should use it effectively, can be overwhelming for the uninitiated.
Below, we break down business finance and explain how it can be used to help your business.
This article will cover:
What is business finance?
Business finance includes any activity where businesses raise funds to help with starting up or growth.
The main types of business finance fall under two categories: equity and debt.
Equity finance involves raising capital by selling shares in a business to investors. As the value of their stake is dependent on the success of the business, these investors then have an interest in its growth and profitability. They may also bring skills, knowledge and connections that can help the business grow.
Debt finance involves borrowing cash from a lender and agreeing to pay it back in full with interest. This could be as a lump sum, or over a period of time. Unlike equity, you don’t have to relinquish any shares or control in the business.
Why is business finance useful?
Very few businesses have the resources to fund their plans independently. Raising business finance allows you to generate significant amounts of capital, which can be invested in anything from new product lines to international expansion.
As well as monetary support, many forms of finance grant you access to the skills, expertise, and connections of your investors. They will often have been successful entrepreneurs themselves, and be able to offer a wealth of invaluable advice to guide you down the best path on your business journey.
Advantages and disadvantages of debt and equity financing
Advantages of equity finance:
- Equity investors take on some of the risk with their share and have interest aligned to your business – even if plans change
- They can bring valuable resources, skills and experience
- Your investors can provide follow-up funding as the business grows
Disadvantages of equity finance:
- Raising equity requires quite a lot of time and attention, which means less focus on your business
- Your share in the business will be diluted
- There are a host of legal issues and regulation to contend with
Read more: 10 steps to structuring your funding pitch
Advantages of debt finance:
- You can tailor the terms to suit the needs of your business
- There’s tax relief on interest payments
- It’s relatively easy to plan for repayments
Disadvantages of debt finance:
- Lenders will take into account your personal or business credit history
- You could face penalty charges if you go over your overdraft limit
- If your cash flow fluctuates, repayments could be challenging
Small business financing
It’s a tough old world out there for small businesses, as the ONS UK business death rate – which has been steadily rising for the last few years – will attest.
Business finance is the lifeblood of the startup and growing business economy, oxygenating its growth and survival.
And though the funding available to many small businesses dried up in the wake of the financial crisis, this proved to be fertile ground for a range of alternative means of finance, such as invoice finance, asset finance, and crowdfunding.
Read more: How to get funding without a bank loan
Sources of business finance
Below, we take a look at some of the major sources of finance available to small businesses.
Business angels are wealthy individuals who invest in high-potential businesses for an equity stake. They can do this alone or through an angel syndicate.
When looking for an angel investor, think about what value they can bring to your business through their skills and experience (rather than just their wealth).
Learn more about Angel finance here.
Equity crowdfunding uses online platforms to connect businesses with hundreds of thousands of potential angel investors, who may also become customers.
Again, your business will need to produce a business plan and financial forecasts to woo potential investors. Most crowdfunding platforms allow you to post a video summarising the investment opportunity.
Find out more in the Crowdfunding section of our site.
Venture capitalists look for unique businesses with the potential to generate high returns. This is because they invest in a portfolio of businesses with the expectation that many will fail. Venture Capitalists typically like to see a proven track record, so rarely invest in early-stage startups.
Because of this, you will need to provide a comprehensive business plan detailing your success to date, information about the founders, and growth plans.
Find out more in our venture capital section here.
Private equity consists of medium to long term investments or growth capital for businesses with high-growth potential.
Private equity investors will usually look to improve profitability and invest in new product lines or services, or expansion into new territories. They will also introduce a management structure and corporate disciplines to the business in order to foster growth.
Private equity investment lasts between five and seven years on average. After that, the firm sells its shares, exits the investment, or publicly lists the company.
Visit our private equity section for more information.
Initial public offering
An initial public offering (IPO) is a major step in a company’s growth. This is where its shares are listed on a stock exchange, where they are sold to institutional investors, larger investors, and sometimes, the general public.
As well as raising money for growth opportunities, a listing can increase the profile of your company to customers, suppliers and peers.
Read about how to plan for an IPO successfully here.
HMRC’s SEIS and EIS schemes
HMRC run a range of schemes that offer investors tax relief for investing in businesses which meet specific criteria.
Click the links below to find out more about the schemes:
Overdrafts and bank loans
Overdrafts can be used to finance working capital and fund short term plans. Loans are good for making larger, longer-term purchases.
Peer-to-peer (P2P lending)
P2P lending uses internet platforms to match lenders with borrowers. These loans can vary in size, from small amounts in the thousands to larger amounts in the millions. Platforms either charge a fixed fee, or allow lenders to bid for loans by offering competitive interest rates.
Platforms will usually require your business to have a trading track record and to provide financials. They will also conduct a credit check to assess your suitability.
Asset-based finance is a term that covers invoice finance and asset-based lending.
Invoice finance can be used to generate cash flow by releasing money from unpaid invoices. It is available to any business that sells products or services on credit to other businesses.
Invoice finance can either be raised against individual resources, or against turnover in total.
With asset-based finance, finance can be raised against anything from stock and property to plant machinery, and even intellectual property.
Find out everything about asset finance here.
Leasing and hire purchase
Leasing and hire purchase can be used to pay for assets such as office equipment and vehicles. It involves a leasing company buying and owning the equipment, which your business can rent for as long as needed (with interest).
It’s a great option if your business is in need of new equipment that would be otherwise be unaffordable.
You have the option to buy the equipment at the end of the agreement. If you want to own the equipment, but don’t have the upfront capital to buy it outright, then you can use hire purchase. This involves a finance company buying the equipment and you repaying the price, plus interest.
Export and trade finance
Export finance covers a range of financial products from banks that make it easier for businesses to get involved in international trade.
If you’re exporting, export finance helps to reduce the risk of defaulting or delayed payment. It’s also often the case that if your business uses overseas suppliers, they will want to be paid before shipping. This means you need export finance to bridge the gap between importing materials and receiving money when the products are sold.
Export finance tools include bonds and guarantees, which give the buyer compensation if the seller fails to deliver. You can also request letters of credit, which are issued by a bank and guarantee that correct payment will be received on time.
Trade finance helps businesses purchase goods from both international and domestic sellers, usually for specific shipments of goods, or for specific periods of time.
Growth finance and mezzanine finance
Growth and mezzanine finance are tailored to the specific needs of the business. The repayment plan is matched to the revenue forecast of the business.
Mezzanine finance is a hybrid of debt and equity finance.
Growth and mezzanine finance are typically used to finance the expansion of existing companies by VC investors, or for strategic investments.
The above should have given you some indication of which type of business finance is right for you.
It may be that over the course of your company’s lifetime, you explore many different funding avenues, depending on your needs at the time.
If you would like to know more about small business financing, you can visit the following pages: