Raising money is one of the hardest things you will do in business. It is never a job completed either, as your business grows, so does your need for capital. Your business requirements will probably be a lot more than just a small business loan. Here's what you should know about raising finance for your small business.
Why SMEs Need to Raise Finance
Your business will have very specific reasons for wanting to raise finance. The British Business Bank conducted a survey last year which sought to establish some of the broader reasons why small businesses need to raise finance. Here are the top 3:
1. Lack of business-scaling affects UK productivity - Without businesses being allowed to scale and flourish, the UK's lagging economy will continue unabated. SMEs in the UK are one of the worst performing in Europe for stagnating employee hires after their first three years.
2. A lack of diversity in the bank lending sector - It remains, despite the growth of alternative lenders, that almost 80% of all lending to small businesses still comes from the four largest banks. More SMEs need to approach alternative lenders and likewise more alternative lenders need to approach small business.
3. The SME landscape across the UK is grossly uneven - If you are a small business operating out of Batley, then you are statistically less likely to be offered funding than if you were from the South East. Almost 71% of all SME equity investment is made up of companies based in and around London!
Why Small Businesses Find it Difficult Raising Finance
Most entrepreneurs and SMEs find it tough raising capital for their businesses. This is the reason why so many of them self-fund, or borrow heavily from friends and family. But in order to grow, business needs capital.
One of the biggest reasons for SMEs not being able to grow and/or fully take advantage of their business opportunities is lack of finance.
This difference between the finance available to SMEs and the finance they need to exploit opportunities is called the funding gap. Why this gap occurs is due to the following:
- Limited number of investors
- Large companies and government-backed businesses have an unhealthy appetite for swallowing available funding, squeezing SMEs
- Small businesses are seen as either overly risky, or do not have long enough trading histories
- SMEs also might not have a historical record of funding and finance and providing evidence of being a 'safe bet'
- SMEs are typically run by a single Managing Director, whose decisions are often dictatorial with little or no accountability.
It becomes clear that SMEs are not always favoured by lenders and investors.
For small business owners (and more clearly entrepreneur and start-ups) there are two funding strategies at play:
- Business Loans
- Equity Investment.
These are two very different forms of lending and both have different motivations for getting a return on their investment. And for any business owner, these are key in making the right kind of investment and finance choices for their company.
Small Business Loans - Lenders aren't usually worried about the long-term goals or aspirations of your company. They aren't even concerned about what it is that you do. They are concerned mostly about their own return and whether you (and your company) are a risk to that return. Can you repay them?
Overriding this sense of risk is the very real fact that most small businesses fail. This means that not only do you need to have the facility for repayment of the loan, you will also be expected to take out some sort of personal guarantee as well as coming up with a sound business and financial plan justifying how you will be able to make regular repayments.
Equity Investment Loans - Equity investors are equally concerned about what your long-terms goals for your business are as well as how your medium and short-term plans will address how they will see a return on their investment. The big difference at play here, is that they want to see the growth and value of your company increase.
Because of this Equity investors are sometimes at odds with the goals of the business owner (now part-owner) who are in for the long-haul, not short/medium-term profit.
Where To Find Small Business Finance
So, what are your options if you are looking for a small business loan or similar finance to kick-start your SME?
Business finance has become an increasingly competitive arena; banks have been instructed to become more approachable; alternative finance has become less 'alternative' and there are a growing number of equity and angel financiers ready to bid for your borrowing needs.
The Banks - Nearly always the first port of call for anyone looking for financing options, although not always the best. This line of thought has coincided with the rise of alternative finance. But since the arrival of the Bank Referral Scheme the bank option once again become the number one choice for accessing small business loans.
Crowd Funding - These are online funding platforms that work by 'pooling' investors together through a third party (online platform) to offer business loans to small and large businesses alike. There are different types of crowdfunding; donation crowdfunding, where people donate money in return for some sort of discount or special preferential treatment or because they just believe in what you are trying to accomplish; equity crowdfunding, where people invest in your company in return for an equity stake, or share, in your company; then there is debt crowdfunding, where investors expect their a return on their money, with interest.
Peer-To-Peer Lending & Business Angels - Again they are usually online platforms where individual investors look to lend their money, at their own risk (terms vary), with timescales and returns agreed upon at the outset. In exchange for their investment, business angels will often take a leading role in offering you their experience, knowledge and contacts to further your business. There will usually be a clear indication that business growth and a return on their investment will be achieved within a certain timeframe.
Friends and Family - Even Richard Branson borrowed heavily from his mother when trying to get his Virgin Records label off the ground. Turning to friends and family is a common way of getting a new venture started or by kickstarting a business into expansion. Terms and conditions between family and friends can differ vastly, but if everyone knows what is expected of them and the legal consequences of that relationship, it can be a fruitful one. It can especially help in maintaining your control over your business.
Other types of finance include Asset Finance, Invoice Finance, private equity, cash advance and business grants.
Creative Sources of Finance
You don't always have to go to the banks or give up equity just to get finance. There are probably ways in which you can get creative about how you reduce costs and save money:
Use your own money - Most other investors, banks included, don't like it when you haven't put up some of your own money into your company.
Establish key partners - Getting key suppliers, customers (or distributor) on board early can be a game-changer later down the line. Having them believe in you from the get-go will ensure that they can be willing partners further down the line.
Local grants - Every region and major city in the UK has grants available for businesses to use for start-ups or for small businesses. Enquire with your local government business advice to see what you qualify for.
Ask customers for upfront money - If you can't afford to extend traditional credit terms to your customers then don't, ask the to pay up front or agree to payment on completion.
Don't buy equipment - Consider leasing your equipment instead of buying it.
Outsource - Instead of incurring fixed costs for overheads, wages and equipment, consider outsourcing operations instead.
How To Raise Finance in a Nutshell
There isn't always a magic 'bullet' when it comes to raising finance for your small business, but the solution often comes in how you utilise the wide range of finance options available to you.
You will probably understand that SMEs find it difficult to get funding due to lack of support in scaling business growth, not enough banks competing for business and that business funding itself is highly regional.
Understanding how and why funding gaps for SMEs exist can help prepare you for what type of finance is right for you, whether that be small business loans or pursuing equity or alternative lending.
There are reasons for and against using bank loans, but there are also a range of different loan options you might not have considered too. However, most lenders will like to see a certain degree of personal money being put up too.
Even if accessing external funding is right for you now, then you should also be looking at how to get creative with how you source finance, either through cost-cutting or through payment terms.
Raising finance isn't just about getting a persuasive business plan, it is also about understanding how and why raising finance is important. Understand this and your borrowing decisions will be clearer.