To be successful, a start-up business needs adequate funding. Here’s essential information about funding a new business. 

 

What’s the first step in funding a new business?

Before starting to raise funds, it’s crucial to work out how much you’re going to need. Don’t just think about your immediate start-up costs – consider all the operating costs you’re likely to have in the first year.

It’s a delicate balance. Not having enough money will stop you operating effectively. But if you spend too much, you’ll pile pressure on yourself to generate more money than you would need otherwise. Burdening yourself with too much debt will increase the likelihood that your business will fail.

Obviously, you’ll be looking to get generate income as quickly as possible, and it’s important to estimate what this will be. Bear in mind that it can take time for a new business to begin making regular sales, let alone make a good profit. Consider this when estimating what funding you need to keep the business going in your hugely important first year.

Should I use my own money and that of friends and family?

Many new business owners use their own money to provide a proportion of their start-up funding – in a large numbers of cases it forms the bulk of the initial funding. 

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Using your money 

Investing in your own business is important – it not only provides funds, but can also help you attract funding; you can’t really expect others to invest in your business if you’re not willing to do so yourself.

You may be able to fund your start-up through savings, a redundancy payment, an inheritance, or by using your retirement funds. If you’ve got any valuable assets, such as jewellery, or a luxury watch or car, you could get an asset-based loan. Once an item has been valued and a loan agreed, the money can be with you within a day or two. Asset-based loans are usually for terms of six months.

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There’s nothing to stop you using credit cards to help fund your start-up business. The advantages include that they’re already set up as instant source of credit. 

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Credit cards

But funding a business through personal credit can be a dangerous game. You’re personally responsible for repaying credit card balances – if you fail to do this your credit rating can be damaged.

If you’re going to use a credit card to help fund your new business, treat it as if it were a loan and make regular payments.

Debt can soon pile up – if you don’t pay the balance on time you’ll incur interest charges. Don’t let debt grow to the point that it’s unmanageable – aim to keep your balance at no more than 30% or so of your credit limit.

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Many new businesses borrow money from family and friends to get themselves established. Although mixing business with friendship doesn’t always work, the fact of the matter is that nearly half of start-ups in the UK get funding from family and friends.

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Borrowing from family and friends 

The advantage of this is that the people lending might only want to earn a small amount of interest on their loan (lower than the rates you’d have to pay for a commercial loan) and some may not want any interest at all. A disadvantage of borrowing from family and friends is having to deal with the fallout if things go wrong. If things don’t work out how will you feel about telling them that their money’s been lost?

If this is what you choose to do (or more likely need to do!) avoid any misunderstandings by putting things into writing. For a loan agreement template you could use with family and friends, go to this page of the Clickdocs website.

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How can I finance equipment and vehicles?

Instead of having to get a loan, or waiting until you’ve earned enough money to buy something, you could use hire purchase or leasing.

With hire purchase, you put down an initial deposit  and then pay the rest in regular instalments. After the last payment the equipment becomes yours.

With leasing you make fixed monthly payments. At the end of the lease period you won’t own the equipment or vehicle, but typically you’ll be offered the opportunity to pay a sum to purchase it, to continue the lease, or simply stop it. In the long-run it may workout more expensive than paying for it outright. It can also be difficult to get out of a lease once it’s been signed, and you may have to be VAT registered. But there also advantages, such as:

  • It enables you to get something you might otherwise not have been able to afford
  • You can get the latest model
  • For many leases, if the equipment or vehicle breaks down the finance company has to pay for its repair not you
  • It’s not counted as a loan so it doesn’t affect your ability to get loans.

Video: The pros and cons of leasing and buying equipment

Informi

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The following video highlights the pros and cons of leasing business equipment against buying it outright.  We run through the different approaches, explaining why a business may wish to lease or buy equipment.

 

How could a bank help me?

If you’ve opened a business bank account you may be able to arrange an overdraft. This should only be seen as very short-term funding not a permanent source of finance.

You can approach your bank – or any bank, or commercial lender – for a loan. After the financial crisis, commercial lenders such as banks, tightened their purse strings, meaning that many start-up businesses found it challenging to obtain loans. However, banks are supported by government schemes to increase lending to businesses, and by other regional initiatives, so they will lend if they think they’re making a good investment.

When you approach a bank for a loan:

  • Have a solid business plan that shows why you need the money, how much you need, how you will spend it, what the forecasted returns are, and the timescale over which you’ll repay it – be prepared to explain precisely how you’ve arrived at those figures
  • Don’t present your business idea as foolproof – lenders prefer to deal with people who are realistic rather than naively optimistic, so identify risks and explain how you will manage them
  • Practise what you’re going to say beforehand, for example by having a dry run with a friend.

Could I raise funds through crowdfunding?

Crowdfunding can work for certain types of start-ups.

Is it right for you?

If you’re setting up a very traditional business, such as a builder, hairdresser, plumber, accountant, gardener, etc, unless you have a new and significant twist, crowdfunding is unlikely to be right for you. Crowdfunding seems to work best for businesses that are founded on an innovative and compelling idea that investors can get enthusiastic about.

 

AdvantagesDisadvantages

Can provide an alternative way of funding projects that traditional lenders, such as banks, might shy away from

Some fundraising platforms use an ‘all or nothing’ approach – if you don’t hit you target amount, any funds that have been raised are returned to the contributors

Can help raise awareness of your new product or service, which can mean that you don’t need to do as much marketing as you would otherwise

You make your ideas public and so risk them being copied by others

Can be a quick way to raise funding without needing highly detailed business plans

If you fail to generate interest, people will know about it

 

Some types of funding involve giving up equity in your business – the investors become part-owners, and you have to be a company, or register your business as such

 

The process

Typically, this involves:

  1. Deciding how much you want to raise
  2. Creating a ‘pitch’ / campaign, which is showcased on an online platform for a fixed time-period (e.g. 60 days)
  3. Marketing the pitch, mainly via social media, and responding to potential investors’ questions.

Platforms

Equity crowdfunding platforms include Crowdcube, Growthdeck, SEEDRS and Squareknot, but keep your ear to the ground as more and more are springing up.

Could I get funding from business angels?

Business angels are people who look to invest in a business in return for getting a share of it. Only limited companies can sell shares, so this way of raising finance is not open to sole traders or partnerships.

To attract a business angel, you’ll need to have a solid business plan and be able to convince them your business has the potential for high growth. You’ll also need to demonstrate that you have the skills and drive to make a success of things.

An angel investor will typically put between £10,000 and £500,000 into a business. Some angels come together in groups or syndicates to make their investments. Most angels will look for the business to generate up to five times their initial investment over a three to five year period. 

If you find an angel who’s willing to invest in your business, the size of the stake they get is up for negotiation. You need to ask yourself if the percentage they’re asking for is worth the money they would invest. You would own a smaller share of your business but this might be worth more eventually if the business is successful.

Business angels tend to take a quite active role in the companies they invest in, so both you and a prospective angel need to be sure that you can work well together.

There are networks of business angels, which can provide access to large numbers of potential investors and advice on how to pitch and approach investors. You may be charged for such access.

The process of acquiring equity investment and therefore having shareholders involves the drawing up of legal documents. Make sure that you use suitably qualified and experience professional advisors.

Next Steps

Find out about government-backed support and finance on GOV.UK

Depending on your circumstances you may be eligible for government-backed support and finance including grants, vouchers and loans.

Read more

Is crowdfunding an option for your business?

Crowdfunding – “peer-to-peer lending” (P2P) - is the seeking of finance from a large number of individuals where each gives a small amount of money, sometimes as little as £5, in exchange for a return which is not necessarily monetary.

Read more

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