New companies will often require a certain level of financial resources to get the business off the ground. Cash is needed for a whole range of costs, such as: employing staff, renting business premises, investment in IT, initial production of goods or development of services, and salaries of directors/owners.
Although some startups will be fortunate enough to already have recourse to funds, such as the existing savings of the business owners, many will have to seek external sources of finance.
Established companies that are looking to expand – taking on new staff or moving into larger premises – will similarly often require additional funding, although they may find it easier to raise money than fledgling businesses.
So what are the options for startups and scaleups in terms of securing funding?
One of the most obvious methods of acquiring funds for a new business is to get a loan from the bank. In the case of sole traders, there will be little difference between getting a personal or business loan, since the individual sole trader will ultimately be liable for repayment. Limited company owners will prefer to apply for a loan through their business account if possible, to minimise their exposure to liability.
Although the application process for a bank loan will be fairly straightforward for most business owners, the maximum amount which can be borrowed and the interest rates offered will vary drastically. A bank loan is usually one of the most expensive options when it comes to raising finance for a startup or SME.
Investors and business angels
There are a wide range of investment companies whose sole purpose is to provide funding for startups, with a view to achieving a long-term return on their investment. They will often take shares or stipulate repayments with interest once the business achieves a certain level of profitability. Some will offer more standard business loans, but generally at lower rates compared to bank loans.
Investment companies and individual investors – commonly known as “business angels” – often focus on a specific industry or type of business. The more niche investors tend to offer better rates, as they will have more understanding of the context of the business and may also be more interested in promoting startups in the industry rather than being incentivised purely by profit.
A relative newcomer to the menu of startup finance, crowdfunding is a method of raising money from a large number of individual investors. This type of funding is generally facilitated through an online platform. The money is usually released once a predefined funding target has been reached; if this target is not achieved the money raised will typically be returned to investors.
Businesses that are very niche may often be overlooked by more traditional investors. In this case, crowdfunding can provide a way to connect to individuals who specifically want to buy a product or use a service that is being developed by the business. It is commonly used in the creation of computer games.
Investment trusts and VCTs
Private companies are not permitted to directly list shares for sale to the general public on the stock markets. However, there are other methods of raising finance in return for relinquishing a stake in a business. Apart from finding a business angel, as previously mentioned, it is also possible to receive funding through:
- Investment trusts – companies can indirectly receive funding from the general public via an investment trust. The trust acts as a third-party investment vehicle, using funds provided by their clients to invest in a portfolio of companies.
- Venture capital trusts – these work in a similar way to investment trusts and are commonly listed on the stock exchange. The main difference is that venture capital trusts (VCTs) tend to provide funding to smaller private companies which are less established and require investment to expand.
Friends and family
When entrepreneurs consider setting up a business, they will sometimes seek financial support from their close family or friends, to help them get their new venture off the ground. This may be provided in the form of informal loans or even grants, often without any expected return on investment.
Although this can be an excellent source of funding, if personal relationships turn sour this can cause problems further down the line. An informal loan provided by a friend or family member can become a very contentious issue in the wake of a falling out, even ending up in court.
Credit cards and overdrafts
Despite being an extremely expensive method of financing a business, a surprising number of entrepreneurs will heavily rely on personal credit cards and bank overdrafts in the early stages of starting a company. Interest rates on these types of credit will commonly have an APR of 20% or higher, which can prove extremely draining, even for SMEs which become profitable.
Although this may sometimes be the only available option to new startups, anyone using credit cards or overdrafts to fund their enterprise should seek to repay any outstanding amounts owed as soon as possible.
Entrepreneurs who lack startup funds should consider finding a business partner who may have better access to sources of finance. Whilst a business partner will normally also want to be actively involved in the running of a startup, they can sometimes take a more passive role or even be a “sleeping partner” who does not get involved in the day-to-day operations.
If a sole trader wants to partner up, they will need to change the business structure to a traditional partnership, a Limited Liability Partnership (LLP), or else form a limited company and make their partner a shareholder.
The best way to meet a business partner is through networking. There are various business groups that hold regular events in most cities and many towns across the UK. Online forums can also help to connect people who are interested in a specific industry, and there are even some specific business matchmaking events.