Do you need a bank overdraft?

The internet is transforming how we work and live.

I am not sure if all the changes are good but in business there are new ways of funding a business. This is important because it is not as easy to get bank support.

This post is about Market Invoice, which is an add-on to Xero Accounting Software.

This company enable you to access finance based on individual sales invoices. Their Website is www.MarketInvoice.com.

So, if you wait 30, 60 or 90-days for customers to pay you then you can use the system to bring the cash into your business quicker. This could enable you to grow and serve other customers.

To use the system your business must normally have at least six months of trading history and have annual sales of at least £100,000. Your businesses using us also need to pass our financial and anti-fraud checks.

You apply online and it takes no longer than 15 minutes. And, there are no costs.

As soon as your business is approved, you’ll get a log in to the platform. You then upload your invoice/s and (after checking) the system will schedule your invoice to sell in one of the twice daily trading sessions.

There is an online calculator on their Website. Based on an invoice of £50,000 being paid in 90-days, you’d get £42,255 within a few hours and £6,000 when the invoice is paid. This is a total cost of £2,745 – which is just over 5% of the invoice.

One thing you can do is add this onto your quotes and offer 5% discount for 7-day payment. After all, your business is not there to finance your customer’s business.

Remember, payment terms should always be part of the price discussion – if nothing else keep in mind the value of offering credit.

Equity finance

Equity finance is the next funding source.

This is where an investor or a group of investors take a share of the business in return for an investment.

We will look at three types of Equity Funding:

• Business Angels
• Crowd Funding
• Venture Capital

A business angel can be an acquaintance, a former employer or someone you’ve found through a Business Angle’s network.

A useful Website is https://www.ukbusinessangelsassociation.org.uk/

Angels are wealthy individuals who invest in start-up and growing businesses. The investment can involve time as well as money, depending upon the investor.

Research by the British Business Angels Association estimates roughly £800m is invested every year. They reviewed 1,080 angel investments and found:

• Angels lost money in 56% of deals
• 9% of the deals generated more than 10 times the capital invested
• The average rate of return for successful deals was 22%

Angels typically invest between £10,000 and £750,000. On average, business angels in the UK invest £42,000, and each investor makes around six investments.

As well as cash, business angels can offer years of experience in the business world, not to mention useful contacts to help you grow your business, which can add real value to your business.

Depending on the business it can be best to have many investors. An example could be a restaurant. This is because the investors become customers and promoters for the business.

Schemes have been set-up by the Government to encourage investment into start-up and small businesses. An example is the Seed Enterprise Investment Scheme.

Investors get tax relief of 50% of investments of up to £100,000 per annum plus gains are not taxed.
The pros of a Business Angle are:

• Angel investors can often make quick decisions
• Good for early stage investment
• Business angles can bring knowledge and contacts to the business

The cons of Equity Funding are:

•  You will need to give up a share of the business
• The Angel may want to be involved in the business and have strong personalities

Next is Crowd funding.

This is where a group of people come together to fund a business, each investing a small amount.

Examples of crowd funding sites are as Kickstarter.com and Crowdcube.com

The pros of Crowd Funding are:

• The investors do not get directly involved running of the business.
• You gain a large audience to begin with. It could be that you have 10,000 customers when launching. Investors in your venture are also fans of your business and will help evangelize your start-up adding ‘word of mouth’ marketing as an added benefit.

The cons of Crowd Funding are:

• Not suitable for very large capital intensive funding requirements beyond £1million or so and also for start-ups looking towards expanding in the growth stage through capital injection.
• You need to sell your idea and convince more than one investor in order to reach your target funding amount and it’s not a matter of getting one person to sign a check so campaigning is important in the process.

Next we will consider Venture Capital.

You’ll be hard pressed to find a venture capital or private equity company willing to invest if you’re pre-revenue or very early stage these days. They’re also not really interested in small amounts of cash – you’ve got to be looking for several million before they start to take notice.

Private equity backed businesses are among the fastest growing small businesses in the UK.

Research revealed that while most businesses took longer than originally expected to secure investment, once they received the funding, revenues grew at a much faster rate than the economy as a whole.

The most effective way of raising venture capital is to select just a few firms to target with your business proposition. The stage your company is in, the industry sector in which your business operates, the amount of finance needed and the geographical location of your business all factor in the mix.

To find the right investor a good place to start is British Venture Capital Association (BVCA) from across the UK.

For companies that are beyond the product development stage and want to initiate early stage commercial manufacturing and sales, or expand a business, a substantially larger investment may be needed.

Early-stage financing can be around £500,000; expansion financing around £1 million and management buy-outs and buy-ins around £5 million.

The process for investment whether the amount sought is £500,000 or £10 million is the same. A similar amount of time and effort is required by the venture capital firms appraising the business proposal prior to investment.

For this reason, medium-sized to larger investments are more attractive for venture capital investment, as the total size of the return, rather than the percentage, is likely to be greater than with smaller investments.

The pros of Venture Capital finance are:

• This is more suitable for larger amounts of capital.
• Venture Capital firms will take a more active involvement with the management of the business playing a pivotal role in setting targets, milestones as well as advice on how to get there since returns on their investment is a primary lookout for them.

The cons of Venture Capital finance are:

•  Not likely to entertain smaller investments
• The business aims can be severely influenced by Venture Capital investors who can look for short-term wins.
• There is a major loss of control

So, that brings me to the end of the posts on business funding.

We have covered the 12 key strategies for raising money for your business.

The chances are what will be right for you will be a mixture of different sources of finance.

We hope you found this presentation useful and you now know more about funding options.

Just remember; do research before you invest your money or anyone else’s. And, test small before you bet the business!

Grants

Grants are the next source of funding we will consider.

There are literally thousands of different types of business grants available.

One of the hardest things is finding them, and getting through the application process, which can be long and arduous.

However, if you or your business qualifies, they can provide the financial impetus your idea needs to either get off the ground or grow into something bigger and better.

All publicly funded schemes are designed to encourage new and growing businesses, to bring wealth and ultimately create jobs. To help achieve this, the government makes available a portion of taxpayers’ money to help and encourage enterprise.

This cash gets distributed through a variety of ministries, departments, agencies and organisations both on a national and local basis. Even universities can also provide match funding for research and development grants.

The good news is that most businesses are eligible at any one time to apply for a number of different business start-up grants and support schemes which are distributed in a wide variety of forms.

It is just not possible to say exactly how many grants schemes there are out there. For example, the Enterprise Advisory Service’s main database usually contains over 3,000 open at any time not including those offered by local authorities.

Useful Websites are www.j4bgrants.co.uk and https://www.gov.uk/business-finance-support-finder

The key pro of Grant Funding is that it is free money that doesn’t need to be repaid.

The cons of Grant Funding are:

• It takes time for grants to processed, ranging from months to a year
• There may be additional requirements on your business. For example, helping the community or society in general
• Ongoing additional documentation maybe required

Asset funding

Asset Finance allows you to borrow against assets owned by the business.

Leasing arrangements are essentially rental agreements with the finance company. However, it may not be for the full amount that the equipment costs.

This works in two ways; the lender either buys an asset from you and you rent it back or you borrow against your asset but are still allowed to use it.

The pros of Assets Finance are:

•  It is quick
• Does not involve outside investors

The con of Asset Finance is:

•  The amounts are likely to be small for a small business

Factoring and Invoice Discounting

Factoring is a flexible form of loan, which advances money to a company as it issues new invoices.

This is different to overdrafts or more formal loans, which are usually for a fixed amount.

When you enter into a contract with a factoring company, the factor agrees to control of your invoices, in return for a small fee.

When the factor assumes control of an invoice, they will advance you a percentage of its total value – usually between 70 and 90% of the invoice. They will then take responsibility for ensuring the invoice gets paid; once the money’s in, they’ll pay you the balance due, less their fees and charges.

Factors’ requirements vary from company to company. Some will consider start-ups but typically the company must be operating on a business to business basis and have a turnover of £50,000 or higher.

It is possible to factor key customers and draw down money on individual invoices.

Invoice Discounting is a variation on factoring where the lender still advances money on a business’ invoice but, instead of the lender collecting the debts for the business, the business collects its own debts.

Invoice Discounting facilities are normally made available to established businesses with turnovers in excess of £250,000 which have good systems in place to ensure reliable collections from their customers.

The pros of Factoring and Invoice Discounting are:

Access to an ongoing supply of cash that grows as your sales grow

Benefit from improved profitability as you can pay suppliers earlier, buy in larger quantities and take advantage of any volume discounts available

The cons of Factoring and Invoice Discounting are:

• Credit limits will be set for customers which may affect the way you trade
• Exiting the agreement can be difficult
• Disputed invoices must be dealt with quickly to avoid them being re-coursed
• In the case of factoring, you are reliant on the factor to collect the debt in a timely and efficient manne

Peer to Peer loans

In this post I will cover Peer-to-peer lending, also called “social lending”, is the practice of borrowing or lending money without intermediaries such as banks being involved.

A peer-to-peer exchange site, such as Zopa or Funding Circle will put you in touch with private lenders, who create a personal relationship between you and the lender.

These Websites are set up similar to auction sites like Amazon and eBay, where borrowers and lenders can auction what they have to offer and come away with the highest (or lowest) bidder.

This allows everyone to choose their own terms and interest rates so that the exchange is beneficial.

A number of companies are now well-established in this space, and several offer generous terms.

Zopa waives all fees for loan applications, reduces interest rates for borrowers who make early repayments, and adds only a one-off fee of £130 to the cost of the loan.

The pros of Peer-to-Peer loans are:

•  Elimination of third party makes process quick and easy
•  Choose your own terms and interest rates so that the exchange is beneficial

The cons of Peer-to-Peer loans are:

• Not subject to the same financial regulations as banks, so the loan terms may not be as favourable
• Can damage your personal credit score

Funding your business personally

This posts looks at funding your business personally.

•  Savings
• Pension led funding
• Friends and family
• Personal loans and credit cards

So, there is a good argument that you should use your money before asking anyone else.

There are different types of savings, examples are:

• Cash
• Savings accounts
• ISAs
• Cashing in endowment policies
• House equity

When considering savings it can be useful to think of putting money into your own business as just switching money from one asset to another. It is still your money.

But, rather than in a low risk environment your money is in a higher risk investment; your business.

The great thing about using your own money is you don’t have to go cap in hand to anyone else and it is quick.

There’s also the bonus of not starting out in business with debt, or giving away a large percentage of the business for a relatively small amount of money at an early stage.

There is another advantage too – if you want to pump more cash into the business later on, the bank and investors often like to see you’re committed to a venture by putting your own money behind it.

The pros of using your own savings are:

• You get all the profits and retain control
• You don’t have any interest repayments or loan charges (unless remortgaging your home)
• It demonstrates your commitment, which can influence financiers at a later date

The cons of using your own savings are:

• You are using up cash reserves that could be useful if your business hits a rough patch
• Assets used to raise money, like your home, are at risk if you don’t keep up repayments
• There can be a lack of due diligence and accountability.

Next is Pension led business funding.

This is where a business owner sets up and uses their own pension fund to provide finance to their business.

The two main vehicles for this are Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs).

Business owners can set up their own schemes and transfer funds in from their existing pension fund.

You will need advice and support from an Independent Financial Advisor. And, the fees will usually be around £2,000.

Once the pension funds are in the business owner’s own fund there are two main funding options:

• A commercial loan from the pension scheme to the company
• The purchase of a qualifying asset

The most commonly recognisable qualifying assets are Intellectual Property like patents, trademarks, designs, copyrights, databases and domain names.

Developing an Intellectual Property pension-based funding strategy requires comprehensive pension review and assessment of company accounts, track record and business plan.

The pros of using your own savings are:

• There is control because it is funding by the directors for the directors
• As well as injecting fresh capital into the business, the Intellectual Property is now held within a creditor-protected pension environment.
• Any increase in the value of the Intellectual Property, or income derived via lease/licence agreements, is free from direct taxation.

The cons of using your own savings are:

• Pension-led funding is not generally viable where available accumulated funds are below £50,000.
• If a business owner doesn’t have a large enough pension pot available to make the process viable, then this form of funding is a non-starter.
• If the business is not successful the business owner can be left with no or very minimal pension provision
• The fees and loss of pension growth can be an expensive way to fund the business

All small businesses are family affairs, when you go into business on your own you family actually comes with you.

Support and encouragement from family and friends is part of our culture. And, for small businesses, family and friends are often a good source of funding.

Funding from family and friends is a cost-effective, popular source of both short and long-term finance. According to the Family Business Network up to 75 per cent of UK businesses are funded in this way.

While family members tend to be more flexible on interest rates and security than the banks, they shouldn’t be seen as a ‘last resort’ funding choice.

If the bank won’t support your idea, are you really prepared to let your family invest?

Be honest with them about the potential risks involved, if your business fails your family may lose their money.

Produce a full business plan and perhaps pay for an independent accountant to critic it.

Keep in mind that funding from family can be a way to reduce Inheritance Tax. This can be a gift, a loan which is written off over time or buying shares in a company which are exempt from Inheritance tax.

The pros of funding from family and friends are:

• It can be easier to get the attention, time and money from family and friends.
• They may require less security, lower interest and more flexible repayments than a bank
• You keep the profits within your family

The cons of funding from family and friends are:

• There is the potential of family conflict if the loan details are not clearly understood
• The whole family may lose money
• Family members may want involvement with the day-to-day running of the business
• Investors may need to request access to their money sooner than you had both planned

The next source of personal funding for us to consider is personal loans and credit cards.

Personal loans can be easier to obtain than business loans or overdrafts. And, the interest charged on personal loans or credit card when the money is used in the business is tax deductible.

It’s not the ideal way to start your business but many entrepreneurs have successfully funded the early stages of their venture this way. The most famous in Google who used credit cards in the mid 1980s.

The pros of personal loans and credit cards are:

• The ability to retain maximum equity means the less you need to give away when you take large funding.
• The ability to escape interest for over a year on either upcoming purchases or funding expenses already incurred would certainly help your business’s bottom line.
• Credit cards are unsecured and allow you to draw down money when you need it.

The cons of funding from family and friends are:

• Start ups are inherently risky, and when you use personal loans and credit cards you are gambling with your personal credit score.
• Debt collectors will after you personal income/assets to recoup what you owe.
• The potential to spend more than you can afford to pay back is not unique to credit cards.  But misuse of any small business funding vehicle can put you in the hole, which is why you should handle them with extreme care.

That brings us to the end of funding the business personally, next we will look at a range of other options.

Funding from customers and suppliers

With customers you can ask for:

• Deposits
• Full or part payment with order
• Stage-payments

All three will ease cashflow and eliminate or significantly reduce the need for funding.

If this seems like something you couldn’t do then it can help to take a moment to work out the value to your customers of offering credit.

If you offer 60 days credit on say £3,000 the value to the customer is less than £40.

£3,000 x 8% x 60/365 = £39.45

This is less than one and a half percent of the total price, is this really the difference between someone choosing you over another provider?

If it is, then the customer could be a highly price conscious (and unlikely to be an ideal long-term client for you) or they may value the credit because they do not have the money to pay you!

The other way to get funding from customers is to ask them for support. Golf Clubs do this with debentures.

An example of an established business doing this is Hotel Chocolat. They raised money for expansion for their business from customers by offering a Chocolate bond.

Not only did they raise money, but they got extensive press coverage.

They offered bonds of £2,000 to £4,000 which gave the investor different packages of chocolate.

The process took six months, cost £50,000 in fees but they raised £3.7m.

This maybe much more than you need but can you use the principle?

Once again, we see the value of creativity in business. Remember, there are no rules.

As well as customers there may be suppliers who are able to help you.

This could be with very generous credit terms, stock on a sale or return basis or a cash investment; especially if you sign a long-term contract to buy from them.

Pubs do this with new tenants who want to spend money to refurbish and re-launch a pub. The tenant ends up buying stock at higher prices than what they can buy in the supermarket but they have the cash they need to launch.

That covers the basics of bank funding and getting support from customers and suppliers.

In the next post we will look personal sources of funding.

Bank funding

This is the first in a series of posts about business funding.

Ever since the world’s bank stopped lending to each other in August 2007, many small firms have found it very difficult to get the finance they need.

There are two types of facility offered by the bank, an overdraft or a business development loan.

It is best to use overdrafts for temporary funding. For example, if the cashflow forecast shows a shortfall for 6-9 months.

If you require a longer-term facility then consider a business development loan. This is because the rates are lower for a loan, and with an overdraft you’ll need to rearrange it every year which takes time and energy.

Bear in mind that the money you need could be a mixture or short and long term funding so consider splitting this in the cashflow forecast.

Whether you apply for an overdraft or a loan the banks will be looking for five key things:

First, there is serviceability. The question on the banks mind is “can the business generate cashflow to cover the repayments?”

This will often come down to a sales forecast so it helps to have extensive market research, a detailed marketing plan, letters of intent from prospective customers or better still signed orders.

Second, the bank will be looking for security to back the lending.

If the business cannot afford to repay the debt how will the bank get its money back? Banks will usually ask for personal guarantees.

Are you prepared to risk your home to fund the business?

Third, the bank want experience; a proven track record and being involved in the industry will go in your favour and against you if you launch a business in a sector you have not worked in.

They will also value business experience of running a company and will like to see a strong management team.

A bank will like a business to have an accounting system, budgets and management reporting in place. Often the bank will insist on management accounts being completed as part of the condition of the facility.

Fourth, the banks are keen to see other funding which they can match.

So, if a business needs £20,000 they are more positive about lending £10,000 if there is £10,000 coming from elsewhere.

Banks like to see other investors or grant funding because it shows other people are backing the business.

Fifth, a bank will required a comprehensive business plan with cashflow, profit and Balance Sheet forecasts for three to five years.

Many banks have their own business planning software or templates that you can use.

However, whatever the banks say (or don’t say) they don’t like risk.

If your business has yet to file accounts or has a trading record of just a few years, the banks will consider you a very risky project.  And, if you’re still at the pre-revenue stage the perceived risk rises through the roof.

The caution of banks can slow down the whole lending process. Even if a bank does eventually advance the cash your business needs, the gap between the initial application and the green light can stretch to months.

But, if you think about this from their perspective it is easy to understand.

Keep in mind that if you apply for a facility of £10,000 over five years at 8% they will generate a little over £2,000 of interest.

This is the banks total revenue and from the arrangement from which direct costs and overheads need to be deducted. If it is an overdraft this could be an annual review so the profit on the deal may be as low as £1,000 or less.

Also bear in mind that the bank gives you the money today but they their profit over five years, so inflation makes the interest worth less.

So, one bad debt can eliminate the profit from one manager’s portfolio.

To help encourage lending to businesses the Government have a number of schemes.

The three schemes we will look at for this presentation are:

• The Enterprise Finance Guarantee scheme
• Export Enterprise Finance Guarantee scheme
• Community Development Finance Initiatives

The Enterprise Finance Guarantee scheme replaced the old Small Firms Loan Guarantee scheme.

Launched in January 2009, the loan scheme provides a government guarantee to help boost the credibility of small business loan applications.

Although established small and mid-sized companies have benefited the most from the scheme, start-ups in the first three years of business account for 37% of all loans offered, with 17% attributed to businesses within their first three months.

Like any normal lending arrangement, the cash for an Enterprise Finance Guarantee loan comes from the bank but the government will underwrite 75% of the loan.

In theory this means you have a chance of securing a business loan even if you don’t have the collateral to back it up.

Loans range in size from £1,000 to £1m, and the time span can range from three months to 10 years.

You can choose to receive the loan in a lump sum, or break it up into regular chunks to suit your business strategy.

The scheme is designed to suit all sorts of needs and circumstances. You can access the finance to:

• Increase a company’s working capital
• Refinancing an existing loan
• Convert an overdraft into a term loan

In addition to the standard capital and interest payments demanded by the lender, Enterprise Finance Guarantee loan recipients have to pay a premium to the Department for Business, Innovation and Skills.

This is usually equivalent to 2% per annum on the outstanding balance of the loan, and is assessed and collected quarterly throughout the loan’s lifespan.

Although this is a Government scheme, the decision on whether or not to grant a loan using this scheme is wholly delegated to the bank; the government does not have a say.

Like any loan application, an Enterprise Finance Guarantee loan requires an application and a raft of supporting documents, including a business plan, management accounts and financial projections.

The Export Enterprise Finance Guarantee scheme is similar scheme exists for businesses that trade overseas but the scheme only covers 60% of the loan.

Community Development Finance Initiatives are loans that are delivered on a local level and are for deprived communities. A Website will help you find an initiative in your area www.FindingFinance.org.uk.

The pros of Bank Overdrafts and Loans are:

• The loan is not repayable on demand and so available for the term of the loan.
• You do not have to give the lender a percentage of your profits or a share in your company.
• Interest rates may be fixed for the term so you will know the level of repayments throughout the life of the loan.

The cons of Bank Overdrafts and Loans are:

•  Larger loans will have certain terms and conditions that you must adhere to, such as giving the bank quarterly management information.
• Loans are not very flexible – you could be paying interest on funds you’re not using.
• You are likely to need to provide a personal guarantee which puts your home at risk.

But, banks are not the only game in town so the next post will explore funding from customers and suppliers.