Small Business Finance

Compare what type of of finance is available to UK SMEs & discover the best option(s) for your business.

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There were almost 6 million small businesses in the UK as of December 2019, a figure which represents 99% of all UK enterprises. And of those SMEs who’ve achieved sustainable growth and success, chances are they’ve got one thing in common: they’ll all have used small business finance at some point in their journey.

If you’re considering ways to finance your small business, this guide will help you understand the types of small business finance available to you, what risks to prepare for, and – ultimately – which SME financing approach may be best for you.

What Is Small Business Finance?

Loans are the most traditional form of small business finance, though the internet has brought about a host of new financing methods, including crowdfunding and peer-to-peer funding.

Generally speaking, small business finance breaks down into two categories: debt and equity. Debt financing covers options such as secured and unsecured SME loans, debt factoring, invoice factoring and asset financing. On the other hand, equity funding tends to come through outside investment (from angels or venture capitalists). Which route is right for your business will depend on a number of factors.

But before we dive any deeper into the different types of SME business finance, there’s a higher-level question that’s important to ask: :

Is Small Business Finance Right For Your Business?

Small business finance comes at a cost – either in the form of a debt or loss of equity and it is important to understand each form has its pros and cons. Indeed, either may be better to forgo altogether and bootstrap the business with profits. Growth may be slower, but debt financing costs and loss of equity have come back to haunt many business owners. 

Just remember: debt and equity financing is not the only option for funding your small business. Further on in the guide we’ll also discuss family loans and business grants, both of which are good alternatives to consider.

As mentioned, there are two broad categories that SME financing falls into. And below are five types of small business finance that fall under the Debt category.

1. Secured SME loans

Secured loans are loans that use one or more of your assets as collateral. Collateral can be anything owned by you, or your business, that has a cash value. Vehicles, inventory, equipment, etc. If you fail to repay a secured SME loan, the agreed-upon collateral can be seized and sold by your lender to make up for their losses.

Pros of secured SME loans:

  • Lower interest rates.
  • Higher loan amounts.
  • More lenders to choose from.

Cons of secured SME loans:

  • You risk losing your assets.

2. Unsecured SME Loans

An unsecured loan is the opposite of a secured loan. There is no collateral, so a lender can’t seize any of your assets in the event that you don’t repay. Obviously, this takes some of the stress out of borrowing, but it also means that the pool of lenders is going to be a little smaller. Plus, unsecured SME loans tend to have higher interest rates, and smaller loan amounts, to help protect the lender.

Pros of an unsecured SME loan:

  • No risk of your assets being seized.

Cons of an unsecured SME loan:

  • Higher interest rates.
  • Smaller loan amounts.
  • Fewer lenders to choose from.

3. Invoice Financing

If invoices are a component of your business model, this is a great way to bring in extra cash. Invoice financing is when you take an unpaid invoice and show it to a lender, who then pays you a percentage of the amount on the invoice.

Pros of invoice financing:

  • Faster access to your income.
  • Adds cushion to customers that don’t pay on time.

Cons of invoice financing:

  • Lenders take a cut of your invoices, reducing revenue.
  • You’ll need reasonable proof that the customer on the invoice will pay.

4. R&D Grants

Business Grants are more or less free money from certain institutions, typically the government. So long as you meet the qualifications for a grant, you’re eligible to a sum of cash, no strings attached.

Pros of research and development grants:

  • Free money that you never have to repay.

Cons of research and development grants:

  • Acquiring the cash requires time-consuming applications.

1. Crowdfunding

You may have heard of ‘crowdfunding’ in the context of Kickstarter or Indiegogo, where ‘backers’ invest in a new idea with the promise of receiving first access to, or discounts on, the goods upon launch. However, we’d like to draw your attention to a slightly more business-appropriate means of crowdfunding. 

Instead of offering product-based rewards, other crowdfunding routes offer shares or equity in exchange for funding. Websites like Crowdcube and Seedrs are great examples of this in action.

Crowdfunding is a relatively new form of small business financing that uses campaigns to generate funding. If you have an idea that can excite the masses, you can call on their support and receive donations to bring your idea to fruition.

Pros of equity based crowdfunding:

  • You’re generating funding from individuals that are likely to become customers.
  • Can create hype around a product.

Cons of equity based crowdfunding:

  • Requires excellent marketing.
  • Not always very reliable.

3. Business Angels

Business angels, also known as angel investors, are wealthy individuals who invest in new businesses they believe in. In exchange for their support, startups offer them a share in the business.

Pros of business angels:

  • Angel investors tend to have business experience that you can rely on.
  • Less expectation to repay the investment.

Cons of business angels:

  • You give up a percentage of control over your business.

4. Venture Capitalists

Venture capitalists are like angel investors, except much more serious. These are individuals who, if the right idea crosses their path, are willing to offer large sums of money in exchange for a large percentage of your business.

Pros of venture capitalists:

  • If you believe in the growth potential of your business, venture capital can fast-track you to success.
  • Like angel investors, venture capitalists are likely to have experience and advice for you to rely on.
  • But, unlike many angels, VCs can have millions to spend in small business financing.

Cons of venture capitalists:

  • You will be sacrificing a significant portion of your control over your business, making the venture capitalist similar to a partner or large shareholder.

5. Incubators & Accelerators

For early stage startups, incubators and accelerators can be the golden ticket to commercial success. Being involved in either an incubator — a sort of co-working space, with access to expert mentors and advisors — or an accelerator — typically an intensive development workshop, lasting a few weeks or months — can provide the resources, training and exposure needed to establish a viable business model. 

Many of these programs also offer equity-based funding, to spend on building the business up.

Pros of incubators and accelerators:

  • An invaluable, immersive experience with access to a range of important resources.
  • Mentors at-hand to help with business challenges.

Cons of incubators and accelerators:

  • Tend to only be for startups and early stage young businesses.
  • As with all equity funding, you will be giving up some control of your company.

6. SEIS & EIS

Seed Enterprise Investment Schemes (SEIS) and Enterprise Investment Schemes (EIS) are investment schemes specifically designed to attract investors to small or medium sized businesses. They do so by offering tax reliefs to individuals who buy shares in the SME. 

The amount of relief varies between SEIS and EIS, but these routes typically offer a win-win scenario for SMEs and investors alike.

Pros of SEIS and EIS:

  • Attracts serious, business savvy investors to your idea.

Cons of SEIS and EIS:

  • You do have to sell shares in return for funding, and therefore you’d be relinquishing some control.
  • Investors may not be as emotionally invested in your business as with other equity finance options (instead following this route for maximum ROI). For some businesses, however, this could be a benefit – it all depends how much involvement you want from your investors!

Risks With Small Business Finance

Any time you borrow money from anybody, in any form, you take on risk. 

The size of that risk will depend on the type of small business financing you acquire, how much you borrow, and how you spend the incoming cash.

If you’re strategic about how you borrow, you can help mitigate the fallout — even if the worst happens and your business goes under. Be realistic about your business’s chances of success, and the amount of revenue it will generate, and only borrow money that will increase your potential revenue.

Who Can Apply For Small Business Finance?

Some of the financing sources mentioned above (family loans and crowdfunding) can be used by anyone, while others have stricter requirements. That being said, any small business should be able to find some source of initial capital, it’s just about knowing what you qualify for.

For secured and unsecured loans, you’ll need a solid credit score, specific documentation, a clear business plan, and possibly collateral. Grants will all have unique requirements depending on the type of business you run, while individual investors will have personal criteria that they check for. It all comes down to researching your prospective sources of funding.

FAQs

Create a solid business strategy that you can use to demonstrate your business’s viability. Then, research potential sources of capital that match your business and present your case to the lender.

There are several types of financing for small businesses, including secured and unsecured loans, investments from angel investors and venture capitalists, and loans from friends and family.

UK startups can receive funding through banks, investors, and grants. UKStartups.org has lots of resources for new businesses in the UK on obtaining grants and loans, which you can read through here. Alternatively, you can check out our guide to Startup Loans in the UK

You can! Though there are sometimes strict requirements and long wait times in order to be approved, many new businesses do qualify for grants. To shorten your waiting time, make sure that you are able to provide the qualifications requested.

You can fund a small business without a bank loan in many ways. Seeking out angel investors and venture capitalists is one way to go about it, though you can also borrow money from crowdfunders and relatives.
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