How do I get funding for an existing business?

When it comes to financing your small business, one of the fundamental decisions you’ll face is whether to pursue debt or equity financing. Both options offer unique advantages and considerations, and understanding the differences between them is crucial for making informed decisions about your business’s financial future.

Debt finance

Debt financing involves borrowing money that must be repaid over time, typically with interest. This can take various forms, including traditional bank loans, lines of credit, or even loans from friends and family. Here’s a closer look at the key features of debt finance:

1. Fixed repayment obligations: With debt financing, you’re obligated to make regular payments, usually monthly or quarterly, to repay the principal amount plus interest. These fixed repayment obligations can provide predictability for budgeting purposes.

2. Maintain control: When you take on debt, you retain full ownership and control of your business. Lenders typically don’t have a say in how you run your operations or make strategic decisions.

3. Interest costs: While debt can provide quick access to capital, it comes with the cost of interest payments. The total cost of borrowing includes not only the principal amount but also the interest accrued over the loan term.

4. Collateral requirements: Many lenders require collateral, such as business assets or personal guarantees, to secure the loan. This provides assurance to the lender but may pose a risk to your personal assets if you’re unable to repay the debt.

Examples of debt finance include: bank loans, overdrafts, lease hire, asset-based (such as invoice financing and supply chain finance)

Equity finance:

Equity financing involves raising capital by selling shares of ownership in your business to investors. Unlike debt financing, equity financing doesn’t require repayment of funds but instead offers investors a stake in the company’s potential success. Here’s what you need to know about equity finance:

1. No repayment obligations: Unlike loans, equity financing doesn’t involve regular repayment obligations. Instead, investors receive a share of the profits and losses of the business.

2. Shared ownership: By selling equity, you’re giving up a portion of ownership and decision-making control in your business. Depending on the terms of the agreement, investors may have a say in strategic decisions and operations.

3. Risk sharing: Equity investors share in the risks and rewards of your business. If your business succeeds, investors stand to benefit from capital appreciation and potential dividends. However, if the business fails, investors may lose their investment.

4. Long-term commitment: Equity financing often involves a long-term commitment from investors, as they typically expect to see a return on their investment over time. This can provide stability and ongoing support for your business’s growth initiatives.

Examples of equity finance include: venture capital, angel finance, crowdfunding and IPO/public offering.

It’s worth focusing on different loan types that are typically available to businesses:

• Secured loans: Secured loans, backed by collateral like property or assets, offer businesses substantial borrowing capacity with lower risk for lenders. They boast larger drawdowns, longer payment terms, and lower interest rates, making them ideal for businesses seeking significant capital injections. However, they entail the risk of asset loss and may involve arrangement costs and longer approval times. Examples of secured loans include invoice financing and bridging loans. 
• Unsecured loans: In contrast, unsecured loans don’t require collateral, making them accessible to businesses without substantial assets. They offer flexibility and quick access to funds, but typically come with higher interest rates and stricter eligibility criteria, such as a strong credit history. Examples of unsecured loans include Start Up Loans.

Let’s explore some of these loan examples in more detail. 

Sometimes you need a sum of money to tide you over which would exceed your overdraft limit, for example while you are waiting for a large invoice to be paid, or when you need to order stock to fulfil a big order.

One option is to ask your bank for a bridging loan. Other options include going to companies which specialise in providing fast short-term loans – for example of between three to 12 months – such as Iwoca. As you might expect, the interest rates can be higher than longer-term loans, but an advantage is that they can be put in place extremely quickly.

If your business involves receiving lots of credit card payments, such as retail, hospitality or leisure, you might consider merchant cash advances. This is where you take out a loan and the lender then takes a proportion of income received through your credit card terminal until the loan is paid back. Many lenders only work with specific terminal providers, so your choice can be limited.

Another option is invoice financing – see below for more on this. 

One of the ‘alternative lending’ schemes that have arrived on the scene over the last few years is peer-to-peer lending (P2P), which is a type of crowdfunding.

Peer-to-peer lenders are individuals who lend out their money in return for earning interest. The lending is carried out through intermediaries who operate online platforms. Peer-to-peer lending to businesses – as opposed to lending to private individuals – is sometimes known as peer-to-business (P2B).

P2B lending is a fast growing sector. Some can lend between £5,000 – £1 million, with up to £250,000 being unsecured, depending on your circumstances. To qualify there may be requirements such as having been trading for at least 2-3 years and having a specific minimum turnover.

The advantages of P2B lending include quick decisions and fast availability of funds for approved applications. Interest rates are fixed for the duration of the loan. Loan terms can be flexible  –  from a few months to five years – and there are often no early repayment penalties.

The disadvantages include that interest rates can be quite high for some sites, as can set-up fees. Because your application may not be subject to quite the same degree of scrutiny by the lender as a bank might, you need to ensure that you’ll be able to repay the loan to avoid landing yourself with unmanageable debt. As repayment periods can be quite short, monthly repayments can be quite high.

Applying for P2B loans is normally a straightforward online process. Funding Circle for example, enables you to compare the monthly and total repayments for different loan amounts over various repayment periods.

Mezzanine funding is a cross between a loan and an equity investment.

There are different types of mezzanine funding, but essentially the funder provides the business with a loan and if this isn’t paid back in full and on time, the lender is entitled to take a share in the business – in other words they get equity.

An advantage of mezzanine funding is that there is no need to provide company or personal assets as security against the loan. There’s not a huge amount of ‘due diligence’ so arranging mezzanine finance tends not to take as long or cost as much as other options. 

The disadvantages of mezzanine funding include interest rates being high and of course the risk of giving up a stake in your business if things go wrong and you can’t repay the loan.

Make sure that you budget for the costs involved in finding investors and concluding legal agreements with them. To raise a couple of hundred thousand pounds of equity investment may cost at least £20,000.

If within a couple of years, you need more money your investors may be worried about pouring good money after bad. However, if in the medium-term you need additional funding to move into new markets, increase production, or take advantage of a new opportunity, they may be willing to increase their investment.