Self employed outlook- Raising finance
This blog post is the first in a series for business owners and the self employed.
Marc Lawson of Business Vision Accountants outlines the options for financing your business.
Every business from its commencement and through its development and growth will need finance.
The forms of finance and methods of obtaining them have substantially changed in the last 10 years so to help you I’ve set out below some brief points on the type of finance now available and guidance on how to use those choices.
Sources of finance
Peer 2 peer lending
This has now become a major source of finance for businesses. The process works by a web based company acting as the middle man between investors with money to invest and business owners who are keen to attract borrowing at competitive rates without necessarily having to resort to high street banks.
One of the biggest of these is Funding Circle. The process works by a business putting forward a business plan. Funding Circle will then credit rate that plan on behalf of its investors and publish it (assuming they give it the go ahead) on their website. After a short time the business will then have a long list of potential investors and assuming they have sufficient offers to cover their original loan request, then they simply need to give the go ahead. Funding Circle will then collect loan repayments direct from the business (so that there aren’t hundreds of individual repayments) and give out interests to the investors.
Bank loans and overdrafts
Banks are still very active in the market of lending and typically lending would take the form of an overdraft or bank loan. Overdrafts are a very flexible form of finance which, with a healthy income in your business can be paid off more quickly than a formal loan. The downside of an overdraft is they are typically repayable on demand and renewable annually so are not as certain as other forms of lending.
Many businesses appreciate the advantage of a fixed term loan. This gives them the comforts that regular payments have to be made on a loan and this makes for costing and budgeting easier. They may also feel that, the bank is more committed to their business for the whole term of the loan.
Interest rates are relatively low at the moment but banks have typically sought to charge a higher “base rate plus” so rates of 8 or 9% are still common.
Savings and friends
When commencing a new business, very often money invested will come from the business owners’ personal savings or family and friends.
It is even more important to set out a good business plan if you’re investing your own money and that of family and friends. 2 out of 3 businesses fail within the first 3 years although every business starts with a high level of confidence of success. Getting a business plan reviewed by a third party such as a friendly bank manager or accountant is highly recommended.
Like other lenders, business owners should consider that money invested needs to be assessed from a risk point of view. Typically business owners will be the last person to get paid if anything goes wrong with the business. With clever structuring, the money invested can be protected to a greater extend.
Increasingly cropping up, there are many new, weird and wonderful ways of getting finance and we would recommend that these are also reviewed. For example there are now lenders that will provide retailers with a credit card machine and will take repayments on a loan based as a percentage of the sales. This means that if sales are low then the loan repayments go down accordingly. This is particularly suitable for seasonal businesses. There are too many to note but contact us on the details below if you are seeking guidance.
Regardless of the method of finance, there are certain steps that need to be taken in most cases. It’s important to realise that the deal must not only be suitable for the lender but also that the business owner checks the need for finance is correct and that the use of the money is for appropriate business purposes and not simply a bail-out fund that will unravel in a few years’ time.
The following might be key steps in the process:-
- Create a detailed business plan. Unfortunately many businesses’ plans are sketchy at best and will often lead to a lender bailing out immediately. Typically the business plan should include:-
-The objectives and aims of the business.
-The purpose of the required funding.
-The business ownership and history.
-Management and responsibilities. Particularly the skills set of the managing director as lenders will want to know that there is a degree of financial savvy in that part of the business to protect their investment.
-Products and market share.
-Sales plan and strategy.
-The financial position of the business with a detailed forecast
- Decide on the source of finance. The list above gives a brief guide to available sources but consideration should also be given to government’s sources such as grants and interest free or low interest forms of finance. As a general rule, the length of the borrowing should roughly coincide with the length of the item being financed.
- Does the finance solve the cash flow need? It is important to assess whether the finance is going to be useful, viable and repayable.
- Assess risks. Depending on the source of finance, there will always be an element of risk in terms of changes within the business and this needs to be assessed to ensure they fit the overall plans of the business and represent an acceptable form of risk.
- Arrange for a third party to overview the plans. A business owner, especially in small businesses, is especially optimistic and confident about what they can achieve. Often this will be unrealistic and a third party view from somebody maybe slightly more pragmatic is always recommended. If higher sales are predicted, detailed analysis of exactly these would come from and whether it’s realistic ought to be looked at in great details.
After finance is obtained
The process does not end with obtaining the finance as consideration needs to be given to the personal entity lending money. Clearly they need to be kept happy by having repayments made or having overdrafts maintained below the relevant limits. Any problems arising with the finance in terms of repayments or any large variations on the business plan need to be looked at carefully and the business lender kept informed.
Bear in mind that further finances might be needed in the future and lenders will look at track records to see if previous finance was a) suitable, b) well planned and most importantly c) repaid according to the terms and conditions.
Building up a good relationship with banks or peer 2 peer lenders like Funding Circle are crucial and communication essential in situations where anything other than the agreed arrangements are being met.