Tuesday, 31 May 2011

Options for financing your business

There are a number of different ways to obtain finance for your business.  When deciding which route to take you should consider the use to which the money is to be put, who carries the risk and the overall cost.

All of these questions should be addressed by your business plan, which should include detailed profit and loss, cash flow and balance sheet forecasts.  The rest of the plan should underpin the numbers and cover marketing, sales, HR and operations.  Any lender or investor will want to see this before they make a decision. 

Who takes the risk?
Relative cost
Bank loan
A fixed amount advanced and paid back over 1 – 5 years
The business – unless the bank makes you sign a personal or director’s guarantee in which case it is you
Low (depending on interest rates)

A fixed amount advanced, fixed interest paid  over 5 – 20 years and then the advance paid back
The business
Only available to larger companies
You sell part of your business in return for a lump sum
The investor
Zero to very high depending upon the future value of your business
The investor will want representation and may want some day to day involvement.  Implies you are able to put a value on your business now
Factoring and invoice discounting
The factor advances a proportion of each sales invoice as it is issued and the balance (less a fee) when the customer pays
The factor – as long as the business follows agreed rules.
Factoring includes outsourcing the sales ledger process.  Invoice discounting does not.  Not usually available to very small companies.  May include bad-debt insurance at a price
An arrangement to allow you a negative bank balance for short periods
The bank
High if done over extended periods
Very flexible
Hire purchase or leasing
A third-party pays the supplier for the equipment and then recovers the money from you over a fixed term
The business
HP, finance and operating leases are treated differently in your accounts
Lines of credit
Your suppliers accept delayed payments from you
The supplier
Ties you in to the supplier
Various government and other initiatives
The grant-giver
Zero to low
There will usually be restrictions on the uses to which the funds may be put
Sale and leaseback
You sell fixed assets for a cash injection and then pay the buyer for continued use of the assets
The business
High - depending what happens to the market value of the asset and future interest rates
Builds in long-term committed recurring costs
Business credit card
Use a credit card issued to the business and set up a direct debit to pay it off in full each month
The card issuer
Zero if fully paid off each month – high otherwise
Flexible and gives up to 30 days interest-free credit each month up to an agreed limit

Calculating the best financing route for your business can be complicated.  You need to understand what would happen under at least three scenarios – best case, worst case and most likely case.  This is best done using a cash flow model on a spreadsheet.

Remember that flexibility (future options) has a value in itself.  The greater the uncertainty about outcomes the more you should seek a flexible financing solution.

You can also invest more of your own capital in the business – either in the form of a loan or by purchasing equity (by issuing more shares).  There are also less formal routes to funding for very small businesses such as borrowing from friends and family.

If you'd like to know more about developing a business plan then this event is for you.

Get more great business tips on our website.

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