Each source of finance carries different obligations, responsibilities and opportunities for business. The differences have to be understood to allow an informed choice.
Many small firms confine their financial strategy to bank loans, either long-term or short-term, viewing the other financing options as either too complex or too risky. In many respects the reverse is true. Almost every finance source other than banks will, to a greater or lesser extent, share some of the risks of doing business with the recipient of the funds.
There are a wide range of funding options available to growing businesses including:
Loans and overdrafts
Banks cover a range of financing options overdrafts and term loans. They will provide any sum, small or large. You have to repay the loan, pay interest on the outstanding balance and put up security to cover the capital. A bank may look to the owner to provide a personal guarantee such as an asset which the bank may force the sale of if you default on the loan.
Hire purchase and leasing
Hire purchase and leasing companies provide funds to buy fixed assets such as vehicles, computers, office equipment, plant and machinery. They will provide an amount of money appropriate to the asset being bought. You may have to find a deposit of up to a quarter of the funding and pay the balance off over several years, depending on the life of the asset. Your payments will include interest and capital. The security for the loan is the asset itself and it remains the property of the finance company, at least until it has been paid for.
Invoice factors will provide finance to cover the period between delivering your products to a customer and receiving payment. They will provide a percentage of the value of the invoice (usually between (75-100%) and can, if you wish, manage the whole process of collection for you. The security taken is the full value of the invoices to customers. A variation on this is called invoice discounting whereby you retain responsibility for collection the payment from the debtor.
Venture capital firms, business angels (wealthy individuals who back businesses) and corporate venturers (firms whose primary business is producing a product, but who also back small firms in related sectors), provide risk capital.
Business angels may invest as little as £5,000, but the other sources of funding will not usually look at anything less than £50,000. In return for a share of your company they will put up cash to help fund growth and development. They will expect to share the rewards, but ask for no security and face the same risks that you do in the event of failure.
Understanding the differences in expectation between lenders, who provide debt and investors who provide equity or share capital, is central to seeking funding for your business.