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Types of finance providers

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Unless you're fortunate enough to have a savings account bursting at the seams, you're probably going to have to find another way of financing your business purchase.

But there's more to the process than simply approaching the bank, cap in hand. A somewhat bewildering range of finance providers and finance options are open to business buyers. You need to decide which options are viable in your circumstances, and which ones will suit you best.

Three types of finance are available to business buyers: loans, share capital and grants. Share capital means you are getting finance in return for equity - a share of your business.

What follows is a rundown of the main types of finance providers businesses use.

You need to decide which options are viable in your circumstances

BANKS

Banks offer many different types of loan and interest rates are higher or lower in inverse correlation to the risk you are prepared to shoulder (for example, using your house as security means rates will be lower).

Banks are conservative in their lending so you must present a convincing, thorough business plan, something a finance broker can help you with.

Advantages

  • Familiarity.
  • Easy access: banks are ubiquitous on the high street.
  • You are not sacrificing a share of your business.
  • Flexibility: you can ease cash flow burdens at the outset by arranging a loan where your first few payments are smaller than later payments.
  • Long established and regulated rigorously by the Financial Services Authority (FSA).
  • Debt finance offered by banks is much more accessible to small businesses unlikely to grow rapidly, or at all - the majority of small businesses - than share capital offered by venture capital funds and business angels.
  • Customer service - one-to-one advice and assistance at your bank from a dedicated relationship manager. Most banks also offer telephone banking until late in the evening, sometimes even 24-hours a day.
  • Internet banking means you can keep up to date with your accounts 24 hours a day.

Disadvantages

  • You might require additional guarantees, which might affect your credit rating.
  • You might have to provide security, and even if you don't then this means the interest rate will be higher.
  • People that need the money the most are often turned down.
  • You have to pay back interest as well as the money you originally borrow.

Appropriate for

Small business buyers who do not expect their business to grow rapidly.

 

GOVERNMENT LOAN

The Government set up the Small Firms Loan Guarantee Scheme, which is administrated by the Small Business Service (SBS), to help entrepreneurs with no assets to use as security for a loan.

The SBS sanction loans of between £5k and £100k (or up to £250k for businesses that have been trading for more than two years). The Government guarantees 75% of the loan in exchange for an annual premium of 2% of the outstanding balance of the loan.

The loan can be repaid over a period of between two and 10 years.

Advantages

  • You do not need any assets to use as security.

Disadvantages

  • Additional fee of 2% has to be paid to the Government annually.

VENTURE CAPITAL FUNDS

Venture capital funds (VCs) are generous (often investing six or even seven figure sums) - but only if they think they will get big returns in a short space of time. They only offer share capital, so offer finance in return for a share in your business.

VCs, which represent the pooled financial capital of a number of investors, will be inappropriate for most people, who will want to own most or all of their business and support their family, but not expect much growth. If you intend to buy a newsagent, launderette or a fish and chip shop, for instance, then venture capital will not be for you.

VCs tend to invest in high-risk ventures that find it difficult to get a bank loan. Internet companies in particular are often financed this way.

Advantages

  • A source of substantial amounts of capital.
  • No repayments to worry about.

Disadvantages

  • Have to sacrifice a large part of your company.
  • Will not be viable for most small and medium businesses.

Appropriate for

Ventures turned down by banks because of substantial risk involved. Must have potential for high returns.

BUSINESS ANGELS

Like VCs, business angels expect high returns and shoulder high levels of risk. You can get finance from such 'High Net-Worth Individuals' if are looking to buy a business, consolidate it and then float it on the stock market.

But unlike VCs, they invest at levels - between about £10k and £250k - that suit small businesses' needs.

Business angels are wealthy individuals who sometimes invest in groups and expect equity for their investment.

They often have experience in running businesses and good local knowledge because they tend to concentrate their investment in a particular region. This means they can make a great mentor for an inexperienced entrepreneur with few contacts.

Sometimes angels will have their investments matched by the Government under its Enterprise Capital Funds Scheme

Advantages

  • Willing to invest levels of capital suitable for small businesses.
  • You can often secure investment quite quickly.
  • Often helpful because of their own first-hand experience of running a business.
  • Often have good local knowledge.

Disadvantages

  • Expect high levels of return on their investment, so not viable for businesses expecting low levels of growth.
  • Infrequent investors.
  • Can be difficult to find the right one as they place a great deal of importance on how well your relationship will work (why not try enlisting the help of a finance broker?).

GOVERNMENT GRANTS 

Grants tend to be given for specific projects that either contribute to the regeneration of deprived areas, help disadvantaged minority groups or are environmentally beneficial or sustainable.

If you are disadvantaged yourself in some way, whether physically or through your background, then it's worth looking for charities and other organisations that might be able to offer grant money for your venture.

 

Advantages

  • You repay nothing.
  • Plenty of grant money around for projects that help disadvantaged minorities or contribute to the community or the environment.

Disadvantages

  • Very few businesses will qualify for grant money.
  • There will be strings attached. Money will be given to you on the premise that you spend it on certain things.
  • Grants are usually given for specific projects, so you are unlikely to raise all of the money you need for a start-up venture.

AWARDS

Awards can be won for existing businesses that have excelled in a particular field or for entrepreneurs with the best ideas or business plans.

Prizes are rarely cash-based, anyway. But the publicity you get from winning an award can make you more attractive to investors, who often attend awards ceremonies - so you can network with them whether you win an award or not.

Advantages

  • You do not have to pay back cash prizes.
  • Often a good opportunity to network with investors.
  • And if you win the award the publicity will make you more attractive to investors.

Disadvantages

  • Very few cash prizes given out with awards.
  • Only a select few businesses can qualify to be a nominee, let alone meet the stringent criteria to win awards.

FAMILY AND FRIENDS

For obvious reasons it can be difficult to ask friends and relatives to lend you money, although of course they may offer.

It goes without saying that you should avoid borrowing money off a friend or relative that they cannot afford to lose. And the same applies if the lender doesn't understand the risk and isn't prepared to wait a while to get their money back if the business struggles.

Ultimately, only you can judge if there is enough mutual trust and respect in the relationship.

Any awkwardness you feel in taking money of a friend or relative can be assuaged by offering a share of the business in return - or, of course, by the knowledge that you fully intend to repay them in full, and more besides, when the business starts turning a good profit.

Advantages

  • Although you may well want to reward them if the business succeeds, your friend or relative is unlikely to expect interest on a loan.
  • Likely to be flexible in demanding repayment.

Disadvantages

  • Late or non-payment can sour personal relationships.
  • You therefore might feel extra pressure to succeed.

Appropriate for

Anyone who has a friend or relative with whom they share a mutual trust, who is willing to invest or lend money, and fully understands the risks.

BROKERS

Deciding which form(s) of finance you wish to secure depends on the amount of capital you need, how fast your business is likely to grow, and whether you prefer to have the burden of repayments or sacrifice a share of your business.

Finance brokers can help you work out what your needs are and which finance providers are best equipped to meet them. They can save you the time and effort of researching providers yourself, and using their financial expertise and experience can source the best deal for you from a broad range of finance providers.


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