Financing your business

Sep 19 2006 By Evening Gazette

One of the key considerations when starting a new business is where you will find the finance to purchase equipment or fund your day-to-day expenses, there are a range of finance options available to you including:

* Savings and informal loans from family or friends

* Loans from micro-finance organisations

* Bank loan

* Business angel finance.

* Supplier credit

The starting point for financing any business is to ensure that you have a well-prepared business plan, demonstrating a viable business proposition and answering key questions including:

* Is there a market for your product or service?

* Have you prepared detailed financial forecasts which reflect the results of your market research?

* Have you estimated the amount of finance that you need for long-term expenses such as equipment (capital expenditure) and for the day-to-day costs of running your business (working capital)?

How much capital do you need?

Calculating the amount of capital required for equipment or the purchase of premises is straightforward. However, calculating your working capital needs may take a little more effort.

The working capital of a business is the current assets (typically stock, cash in the bank and people who owe you money) minus the current liabilities (typically money owed to trade creditors, other creditors such as Pay As You Earn (PAYE) and Value Added Tax (VAT), and your bank overdraft).

The amount of working capital you need will vary during the course of the year, and even during the course of a month, but you should allow for the maximum amount that you're likely to require, as a rule of thumb it makes sense to aim for minimum working capital of a month's average sales, multiplied by the number of months it takes to collect payment.

Loan finance

Loan finance is simply money that is borrowed and repaid over a period of time, at either fixed or variable rates of interest and usually require security against a business or personal asset. Terms can vary in length from one year to 25 years and the interest rate will reflect the lender's perception of the risk.

* Micro-finance organisations - if you need a relatively small amount (usually up to about £5,000), or if you have no savings and a limited track record.

* Banks - for larger amounts, but try more than one to get the best deal.

* Term loan - funds borrowed for a fixed term, usually, repayable in equal installments over the term of the loan or some can be repaid in a lump sum at the end of the term.

Make sure you understand the terms that the bank may use and the risks as you may have to issue personal guarantees as security on a loan, which could put your personal assets at risk.

* Business overdraft - provides short-term finance, by running a negative balance on the bank account and a good way of funding short-term requirements. You will only pay interest on the amount you have borrowed and sometimes an annual arrangement fee.

* Suppliers' credit - suppliers may give 30-60 days' credit for their goods or services before payment is due. If you can sell your product or service and get paid before paying your creditors, then this will generate cash into your business.

* Small Firms Loan Guarantee - you may be eligible for this scheme which provides a Government guarantee for loans provided by approved lenders. It provides finance to businesses that fail to secure finance through more conventional routes due to lack of security.

* Current debts - a key issue for any lender will be the proportion of debt compared to the total capital in your business - this is known as 'gearing'. The more debt there is relative to equity, the higher the gearing. Most banks look for a gearing of no more than 50%.

Grants

Grants are usually 'one-off' payments providing a percentage of the costs towards a specific purpose, usually for capital expenditure, but sometimes for a specific activity such as taking part in an exhibition or trade fair. Amounts vary depending on the scheme as does eligibility criteria.

Asset finance

Financial leasing is a way to finance the use of an asset rather than actually owning it through leasing equipment. A lease purchase arrangement provides you with the option to purchase the equipment at the end of the period. Hire purchase enables you to buy via equipment from a supplier through regular payment installments.

Equity finance

Equity finance (or shareholder capital) is the money put into a business in exchange for part ownership. Investors expect a share of the profit which is paid as a dividend.

* Have you looked for external investors? Investors or venture capitalists will be looking for businesses with excellent growth prospects as well as the potential to pay annual dividends. Investors will be looking for a good return when they sell their shares. You will be expected to contribute some equity in order to lever additional funding from elsewhere. Typical investments by Venture Capitalists are £100,000 or more.

* Business angels - are private investors, or groups of investors, who are looking for opportunities to put money into small enterprises in the hope of making a good return. They usually assist businesses during the start up or expansion phase and, as well as money, they often bring a wealth of commercial experience. Typical investments can be anywhere between £10,000 and £100,000.

Hints and tips

* Make an effort to understand the questions potential investors will be asking and make sure that you provide them with all the information they need.

* Even after you have started, calculate the total level of funding required for the next year, and split it into fixed-asset requirements and working capital requirements.

* Think carefully about the term, the cost, the suitability, the timescale and any security required. Remember that cost should not be the sole criterion.

* Keep your lenders informed about your financial position, e.g. giving plenty of warning if you are likely to need to increase your overdraft.

* In times of recession, try to keep as much of your debt as possible as fixed medium-term loans and keep your overdraft requirement to the minimum. In times of expansion, when finance is more readily available, it may be more cost-effective to use an overdraft.

Whatever your finance needs are Business Link can help by working with you to build an understanding of what your business wants to achieve and can identify the most relevant assistance and, if appropriate, help with the identification of funding to ensure you achieve your objectives. Call Business Link on 0845 600 9 006 or email info@tees.businesslink.co.uk to see how you can make the most from your business.