Start-ups - access to finance

Start-up Challenges

Early stage businesses face their own particular challenges in seeking external funding. Whilst various Government-backed schemes have been introduced with the intention of reducing borrowing costs, any commercial lender will still make an assessment of a borrower’s ability to repay a facility, reviewing the borrower’s financial track record and available collateral, which would normally pose a problem for most start-ups.

All new business owners will be expected to have invested at least some of their own funds into their venture before a third party will consider making funding available. Family and friends are commonly the next port of call. In order to avoid potential future conflict, the nature and terms of any funding by family and acquaintances (for example whether by way of loan or equity, the repayment term, whether security is to be granted and interest is to accrue) should be expressly agreed and carefully documented, however close the relationship between lender and borrower.

Traditional Debt Funding

Before approaching any commercial lender, a business should work with its accountants to construct a realistic business plan.  The quality of the business plan, forecasts and projections will often be instrumental in determining the success of any funding application. Broadly, three types of standard finance facility are available:

Overdraft: Mainly used to assist with temporary cash shortages, and repayment can in theory be demanded by a bank at any time.

Term Loan: Finance for a fixed period, on agreed terms for interest and repayment, to fund long term cash requirements.

Asset based lending: Lending secured against specific assets such as items of plant, and – in the case of factoring and invoice discounting – outstanding customer debts.

In all cases, lenders will seek some form of security over assets and/or a personal guarantee from the business owner. Specific lending schemes and alternative forms of finance may assist early stage businesses who find that traditional bank finance is precluded by the funding costs and their inability to provide security.

Some of these alternatives are listed below:

Alternative or Government-assisted Debt Finance

Start-up Loans Programme: £110,000,000 of Government-backed low-cost unsecured personal loans (with an anticipated average principal amount of £2,500) are being made available to entrepreneurs via an on-line application process. It is envisaged that these will be repayable within five years and that mentoring will be provided to successful applicants.

Enterprise Finance Guarantee Scheme: A Government scheme, accessed via existing lenders, and intended to assist them in making facilities available to borrowers where the security offered would otherwise fail to satisfy the bank's criteria.  The Government guarantees to commercial lenders repayment of 75% of a loan in circumstances where all available security of the borrower has been exhausted. Various requirements are imposed regarding the term and size of the loan. In practice, notwithstanding the Government guarantee, the availability of any EFG loan will still be subject to a bank’s normal commercial lending criteria, which may pose a problem for start-ups.

Community Development Finance Associations: Provide loans (usually on a secured basis) to businesses which have been unable to obtain loans from traditional sources. An assessment of the borrower’s ability to repay will be conducted, as is the case with normal commercial lenders, however there is likely to be greater flexibility in lending criteria.

Peer to Peer Lending: A relatively new phenomenon, through which individuals compete as part of an on-line auction process to lend small amounts to businesses. An initial business analysis and risk assessment will normally be carried out by the host of the peer to peer site. Given the limited due diligence, this form of funding is usually considered to involve shorter timescales and lower transaction costs than traditional bank lending. It is questionable however whether this is suitable for early stage businesses – a survey carried out by NESTA in 2013 found that most borrowers via peer to peer lending are established businesses. Notable peer to peer lending sites include Funding Circle and ThinCats.

Equity Finance

Start-ups and early stage businesses benefit from a longer term approach to funding and a willingness to share in the risks of the business venture. These are characteristic of equity funding, in which the funder will acquire a stake in a company and will share in the profits and any exit proceeds after all debt funders have been repaid. It is widely considered that equity investment will have an increasingly significant role to play in supporting early stage businesses.

Provided a business owner is willing to part with a share in his company in return for funding, the most common sources of equity funding are Business Angels, high net worth individuals who subscribe for equity either alone or as part of a syndicate, and usually claim significant tax relief for doing so.

Grant Funding

Grant funding is available from various sources, including Government agencies and charities.  Its main advantage is that, generally speaking, it does not have to be repaid.  Competition for grants can, however, be fierce, and applicants will commonly need to satisfy specific criteria (such as job creation) and, in some cases, match the grant funding with their own investment.  The Black Country LEP has produced a Business Finance Directory which lists sources of grant funding available to start-ups, such as the New Enterprise Allowance and The Prince's Trust  Enterprise Programme.

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