Flexible finance experts your business can count on

Running a business is one of the most challenging – and rewarding – things a person can do. The highs, the lows, the satisfaction of taking an idea and transforming it into a thriving enterprise is unlike any other. When it comes to raising finance, things can get even more challenging.

From improving cash flow, to modernising your business or preparing it for a potential sale, there are countless reasons you might need finance. Yet, no two situations are alike: what may work in one context may be a bad idea in another. Below, we explore the pros and cons of some of the more common ways to raise finance, and why they might suit (or more importantly, not suit) your SME.

We’re going to be covering:

  1. Overdrafts
  2. Bank Loans
  3. Government grants
  4. Invoice Financing
  5. Equipment Financing
  6. Equity Financing

1. Overdrafts

Overdrafts are a very common way for businesses to raise finance. Easily understood and simple to get to grips with, the fact that most members of the public have an overdraft make it a popular option. So, what are the benefits?

Overdrafts – The Advantages

First off, an overdraft is flexible. You only borrow what you need at the time, which often makes it cheaper than a loan. You only pay interest on the overdraft funds you withdraw, and you can stop the business overdraft facility at any time. For example, once your cash flow is more stable. It’s also quick to arrange and there is not normally a charge for paying off the overdraft earlier than expected. So all in all: simple, speedy and useful.

Overdrafts – The Disadvantages

If you have to extend your overdraft, you usually have to pay an arrangement fee. Worse, your bank could charge you if you exceed your overdraft limit without authorisation. The bank has the right to ask for repayment at any time, and although this is unlikely to happen (unless you get into financial difficulties) it is worth bearing in mind.

More importantly, overdrafts may be secured against your business assets. Unlike loans, you can only get an overdraft from the bank where you maintain your current account. The interest rate applied is nearly always variable, making it difficult to accurately calculate your borrowing costs. Unutilised overdraft facilities may be reduced by the banks at short notice, although, again, this is unlikely to happen unless you get into financial difficulties.

2. Bank loans

Bank loans do exactly what they say on the tin. You approach the bank, they loan you the money, you have to pay it back on the agreed terms. However, when it comes to businesses there are a few extra things you need to take into account.

Bank Loans – The Advantages

One of the biggest pros of a bank loan is that you keep control of your company. Unlike some other financing options, banks do not take any ownership in the business as part of the arrangement. Bank loans are also temporary, meaning that once you have paid off your loan, there is no more obligation or involvement with the bank. Compare this with equity finance say, where your company may be paying out dividends to shareholders for as long as the business exists, then bank loans begin to look very favourable indeed. Finally, as the loan interest is Tax Deductible, a fixed rate loan also allows businesses to budget and manage cash flow more accurately.

Bank Loans – The Disadvantages

Because they are such a popular option, it can often be very tough to qualify for a loan. Your business will need to have a proven track record and demonstrate the ability to repay the loan in full. Personal Guarantees may also be required. Finally, a loan with very high interest rates might not be worth it in the long run. Be sure to consult an expert.

3. Government grants

In recent years, the government has been handing out a significantly increased number of grants. These can be a boon for businesses, as there are very few strings attached once the money has been received, and you are often under no obligation to pay it back.

Government grants – The Advantages

The pros are very clear cut. A grant means exactly that: an opportunity to get free money from the government. Once received, your money isn’t repayable, as long as it goes towards the specific business need that’s been approved by the government. Simple!

Government grants – The Disadvantages

The application process for grants can be the stuff of nightmares. Government grants are highly competitive, meaning thousands of businesses across the UK will be competing for the same money. Worse, as the schemes become increasingly popular, the waitlist gets longer and longer. If you need funds now, this lengthy process can be a death knell.

Secondly, it’s important to note that not all government grant programmes fund every business activity. Most grants are designed to help business owners with specific things, say hiring employees, training staff or going green. That means not everyone is eligible to apply, and you need to be very careful to read the small print before you waste your time applying for something you don’t actually qualify for.

4. Invoice Financing

Invoice financing is something that many first-time SME owners haven’t heard of, but it can be a very useful way to free up some cash flow. In short, you get financing based upon invoices you have raised but not been paid for, in effect getting an advance. However, there are catches.

Invoice Financing – The Advantages

The big one: improved cash flow. Invoice financing releases funds tied up in invoices. Quick and easy to set up, invoice financing is relatively easy to qualify for as there is very little risk to the lender. You can also use this function to extend longer payment terms to customers without it affecting your business’ cash. Even better, the credit line is based on the value of your invoices, so can increase in line with turnover. Finally, there’s often no requirement for security, making this a good option for businesses with few or no assets.

Invoice Financing – The Disadvantages

Invoice finance is a very sharp tool for a very specific problem. It is designed to specifically address insufficient cash flow. If your customers pay on time and within reasonable terms, then this is unlikely to be worth it for you. Worse, invoice financing can be much more expensive than other forms of finance. It’s also only available on commercial invoices where the customer is another business. So if you sell products or services to the public, it won’t be available to you.

Another big issue is that your customers might be made aware that an invoice finance facility is in place. Some financing is structured with what’s called a ‘factoring provider,’ who are basically responsible for collecting payments on the original invoice. If someone that isn’t you suddenly turns up demanding payment, it could damage the relationship you have with those customers. A better option could be invoice discounting, which allows a business to retain responsibility for collecting payments, so the customer does not know the arrangement is in place.

5. Equipment Financing

Equipment financing is a way of leveraging tools and equipment and freeing up some cash. As ever, there are pros and cons.

Equipment Financing – The Advantages

First up, cash flow. Big capital purchases can heavily disrupt your cash flow, but through equipment financing you’ll be able to spread the cost out and ease any issues. Even better, once the loan has been paid, you’ll have full ownership of the equipment. It’s also a fairly quick and easy process, meaning you can get your hands on the funds pretty swiftly.

Tax deductions may also be available if the equipment is 100% used for business activities. Finally, if you go for 100% financing, the equipment itself will serve as collateral, should you default and become unable to meet your payments, so there’s no need for down payments.

Equipment Financing – The Disadvantages

The big con when it comes to equipment financing is that you do not own the equipment until the loan is repaid in full, meaning it can be repurposed. Plus, although you don’t own the asset, you are liable for all maintenance and repairs. Equipment financing is also restrictive because – as the name would suggest – you can only use the funds for the purchase of equipment. Finally, it can be quite expensive, with high interest rates the norm.

6. Equity Financing

Equity financing offers companies an alternative funding source to debt. Startups that may not qualify for large bank loans can acquire funding from angel investors, venture capitalists, or crowdfunding platforms to cover their costs.

Equity financing – The Advantages

Equity financing is viewed as less risky than debt financing, because your company doesn’t have to pay back its shareholders. Investors typically focus on the long term without expecting an immediate return. This means you can reinvest cash flow from operations to grow the business, rather than focusing on debt repayment and interest. Equity financing can also be a great help to management, as many investors like to be personally involved in operations. Their backgrounds mean they can give you invaluable assistance in the form of contacts, management expertise and access to other sources of capital. Many angel investors or venture capitalists will help companies in this manner. It is crucial in the startup period of a company.

Equity financing – The Disadvantages

The main disadvantage is company owners must give up a portion of their ownership and dilute their control. If your SME becomes successful in the future, a certain percentage of company profits must also be given to shareholders in the form of dividends. Many venture capitalists request an equity stake of 30%-50%, especially for startups that lack a strong financial background, which can end up being spectacularly costly down the line. Many founders and owners are unwilling to dilute such an amount of their power in this way.

Also, compared to debt equity, investments offer no tax shield. Dividends distributed to shareholders are not a tax-deductible expense, whereas interest payments are eligible for tax benefits. This adds to the cost of equity financing. In the long term too, equity financing may cost you more than debt, because investors incur a high risk when funding a company, and therefore demand a higher cut in return.

How do you know what finance is best for you?

These are just six options, there are others. Perhaps you know exactly what you need, or perhaps you are still a little overwhelmed by the options that are out there. The best thing you can do is speak to an expert.

At The Finance People, we can give you practical and impartial advice about what will work for you and your specific business needs. With a wealth of experience and hands-on knowledge of offering finance to SMEs, our friendly team will be more than happy to point you in the right direction.

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