Guide to funding

Every business requires funds to get started, and there is a range of options out there for you to take advantage of. What’s available will depend on how much you need, the type of business you’re planning to run, and the level of control you want to keep, but essentially funding comes as four types:

• Your own investment
• Investment from others
• Bank Finance
• Grants.

Many companies mix and match their funding sources, perhaps receiving a grant for training, an overdraft to cover day-to-day borrowing, a loan to buy equipment, and investment to provide a substantial amount to get the company up and running.

In brief

• Personal investment
• Funding from family and friends
• Overdrafts and loans
• Business angels and venture capitalists
• Government support
• Grants and other sources
• What to do next

Most start-ups involve some personal investment, especially as it can be difficult to attract further funding unless you’re prepared to put your own money into the business. You might want to use savings, an inheritance, a redundancy payoff, or money from re-mortgaging your home. While borrowing on credit cards and unsecured personal loans are also options, these tend to be more expensive and are not recommended as a solid foundation for a new start-up.

The advantage of putting up your own cash is the independence it gives you – lenders or investors may expect a say in how you run your business; they’ll certainly want a good return for their investment, and they can decide to withdraw their support at any time.

The downside is that if the business doesn’t work out, you could be left with nothing. If you’ve re-mortgaged, you may face large monthly repayments or be at risk of losing your home. You may end up paying interest on other loans for many years, while repayments on credit cards, if you use this option, can be very expensive.

Asking those closest to you for financial help is often an option in the early days, especially if your start-up is too small to tempt investors or banks.

Gratifyingly, family and friends are often less demanding than banks and investors, offering interest-free or low-interest loans.

They could be willing to accept your back-of-an-envelope idea in lieu of a formal business plan.

They may also trust you to get on with the business without their input.

However, it’s important that you explain the risks to them, as well as your goals for the business. Ask them to contribute only as much as they can comfortably afford.

It’s best to put any agreement in writing to avoid potential fallouts later. You’ll need to be clear whether they are offering you a loan that will be paid back or an investment in return for a share of the business. You should ask a financial advisor or solicitor for advice, and then draw up an agreement. This should cover issues such as interest and repayment terms, possible shareholder voting rights, and what happens should your investor want to exit the deal. A few principles agreed on a sheet of paper could save considerable heartache in the future.

Banks are often the first port of call for additional finance.

You can borrow money in a variety of means including overdrafts, loans, asset and invoice financing, but first you’ll need to show the bank that you’re a good risk.

A comprehensive business plan is essential and on many occasions security (business or personal assets) is asked for.

It’s desirable to show you have a good track record in business and that you’re investing some of your own money (or that of an investor) in your idea.

Bear in mind that you may have to pay an arrangement fee in addition to interest on the amount you borrow .

Loans can be a flexible way to finance some of your start-up costs. You might borrow £1000 or £100,000 and pay it back over two years or twenty. You can budget for your repayments and may be able to take a repayment holiday, during which you pay only the interest on the amount you owe. It is sensible to look around for a deal and interest payments that suit you. However, you may find that regular loan repayments cause you cashflow problems, or that you are paying interest on money you’re not using.

Overdrafts can provide a fallback that helps to fund everyday expenses. They often have higher interest rates than loans, but the advantage is that you pay only on the money you have overdrawn. Banks can ask for repayment of the overdraft at any time, so look for a commitment or guarantee, where possible, for the term of your overdraft. This gives you the confidence that it’ll be there as and when you need it for the period you’ve agreed.

If you’re looking for funding of more than £10,000 for your business, an ”angel” may be the answer to your requirements. Business angels are wealthy individuals that invest capital in start-ups in return for shares in the business. In addition to cash, they can offer their valuable expertise.

Venture capitalists invest substantial sums in high-risk businesses or those that have the potential to generate substantial amounts of money in the longer term. They tend to expect a big say in how the business is run, and set targets that must be met before each stage of funding is released.

Either of these options will mean relinquishing a certain amount of control – and profits – in your company, but a venture capitalist may be an attractive option if you don’t expect to produce much cash at first. Unlike banks, which typically expect immediate payments on a loan or overdraft unless payment holidays are agreed upfront, outside investors don’t usually expect to see money back until the business can afford to pay it. It is important to make sure that you understand the terms of repayment upfront so that you can be confident and clear about what you’re aiming for.

Interest-free loans, subsidised consultancy services and cash grants are all available from the Government under its "Solutions for Business" portfolio.

This range of schemes includes:

• Small Loans for Businesses of up to £50,000 if you have a viable business plan but have been refused bank finance
• Finance for Business Financial solutions, including loans and investment, if you have a viable business plan and have not been offered support by banks and investors

Enterprise Finance Guarantee Scheme

• If you are eligible, the Government will back 75% of your loan from an approved lender, which means providing less security on your borrowing
• Turnover during the previous 12 months must not exceed £25m
• Some sectors are excluded from this scheme, and restrictions may apply to others. Please speak to your Business Manager for full details
• The minimum loan amount is £1,000, with a maximum of £1m
• Loans can be scheduled for terms between 3 months and 10 years
• In addition to the loan interest and arrangement fee, the customer is required to pay a premium to BIS. This is currently 2% per annum, based on the reducing balance of the loan. The premium is paid quarterly by Direct Debit. (For premiums due and collected in 2009, BIS will reduce the premium rate to 1.5%).

Grant for Business Investment

• A minimum £10,000 grant to support business investment or job creation projects.

Grants are a great way of funding a specific start-up cost, such as essential machinery, research or training. They are usually awarded for a specific project or purpose and as long as that’s what you use it for, you won’t need to pay the money back. It’s common practice to ask for business owners to match the grant sum.

Some charities, such as The Prince’s Trust, are well-known for giving grants to start-ups. However, the main funding bodies, apart from central Government, are either local authorities and councils, or local development agencies, such as the Regional Development Agencies (England), Scottish Enterprise, the Welsh Development Agency, Invest Northern Ireland and the European Union

If your business is in a sector that isn’t served by the usual lenders, or you’re setting up in a disadvantaged area, you might secure a loan for between £50 and £1million from a Community Development Financial Institution (CDFI). A CDFI loan can be used as capital, to buy equipment or premises, or fund a marketing campaign.

You may also be able to apply for a grant from Peer Group Lenders, such as the Ethnic Minority Enterprise Network. The Business Link Grants and Support Directory has listings of organisations that may be able to offer you grants, subsidies or advice.

Applying for a grant can be time-consuming and competition is fierce, but any money secured will be a valuable addition to your start-up fund.