Financing your new business

Chartered certified accountant Raphael Coman of Coman & Co explains the key start-up funding options

Finance is important to any business – especially at launch and during times of growth. Success can often depend on having access to the right finance, since many profitable businesses fail simply through a lack of cash. The following explains 12 common sources of start-up and development finance.

  1. An overdraft is the amount you owe on your account to the bank. Bank overdrafts can be repaid more quickly than formal loans and have no early repayment penalties. Banks often prefer to grant or extend an overdraft rather than make a loan.
  2. A loan is a more formal debt. Bank loans cannot be recalled, unlike overdrafts, and they can improve the certainty of cashflow forecasts and budgets.

    Banks will ask for security on larger loans and this is often your home. This is known as a personal guarantee, and is a high-risk option.

    You may secure loans of between £1,000 and £1 million under the Enterprise Finance Guarantee scheme. Under the scheme you pay a 2% annual premium on the outstanding balance of the loan and the government guarantees to pay the bank 75% of the loan value if you default.

    You should have a business plan ready to show to lenders and investors and agree the terms of the financial arrangement in writing.

  3. Obviously, you can invest personal savings in your business. The interest you forgo on savings is normally less than the interest you pay on borrowings. Interest received on savings is normally liable to tax, whereas interest paid on business borrowings can help reduce taxable profits.
  4. You could ask family and friends to lend you money, provided they understand the risk of loss if the business fails.
  5. Limited companies can issue shares, although this can dilute your ownership and control of your business.

    The British Venture Capital Association and the British Business Angels Association can introduce you to possible investors. A venture capitalist can bring skills and networks to strengthen your business, but they will normally want to be a director and will push for growth.

  6. The Venture Capital Trust scheme and Enterprise Investment Scheme (EIS) both provide tax incentives for investors wishing to buy shares in growing businesses.

    Under the EIS scheme there is scope for you to raise finance by purchasing your own company shares and deferring any capital gains you have made in the past three years.

    If a company disposes of more than 10% of its business under the EIS scheme, it will also be exempt from tax.

  7. Organic growth through retained profits does not require any borrowing commitments or dilution of control. Reducing stock and debtors will improve cashflow.
  8. Factoring enables you to obtain an upfront payment for the money owed to you by your customers. Commonly, factoring companies will lend up to 85 per cent of the amount outstanding.
  9. Hire purchase allows you to pay for equipment in instalments, but it can be costly.
  10. Leasing can enable you to use the latest equipment or machinery without actually owning it.
  11. A small company pension scheme can be used to buy certain assets, such as commercial property, for use by the business and can borrow up to half of the finance required.
  12. Government and local authority grants and loans on favourable terms may also be available.

Getting it right

Raising finance is always challenging, especially for small businesses and particularly in a recession. In deciding on the best source of finance, you should take account of a number of factors, such as taxation, the long-term plans of the business and its ability to meet its repayment commitments.

Financial planning is important, particularly when considering whether the business has the resources to manage expansion. A business plan is usually necessary for borrowing from a bank or other lending institution. It is also useful for focusing your mind on your objectives.

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