Sources of funding for early stage and start-up businesses

Small businesses (0-49 employees) by number account for over 99% of total UK businesses, with there being over 5.94 million businesses registered at the start of 2020, so there is no doubt that these remain a very important contributor to the economy of UK plc, accounting for circa 60% of employment in the UK private sector and around 50% of turnover. To further emphasis the point, 665,495 companies were formed in the tax year 2019/2020, which works out at more than 1 company per minute being born! ?Whilst a number of businesses fail/cease to trade in the first 5 years, over 40% of businesses that were formed in 2013, were still in existence 5 years later.

In this article, I will cover off the potential sources of funding to get a new business off and running and turn a great idea into something real and tangible. Whilst there are a number off ‘external’ ways/sources to fund the budding business, self-funding is by far and away still the most preferred option. Indeed, based upon information from the Institute of Directors (2016) a huge 82% of start-ups used self- funding to start their business – with 56% of start-ups using this as the only source of funding. So what do I mean by self-funding??- well, basically raising the funds to start the business from cash savings, personal borrowing and/or friends and family.

Friends and Family

If you don’t have a strong track record (and let’s, be honest most people starting a business are first timers) of launching successful businesses, it is often difficult to secure funding from traditional Bank’s. So raising money from friends and family may sound like a good option – repayment and other terms are usually relatively flexible and in most cases, you don’t have to go through the ordeal of putting together extensive business plans and forecasts and subjecting yourself to background checks. Beware though, raising money from those nearest and dearest does have its pitfalls – personal relationships can be damaged forever if things don’t go according to plan, and you are unable to re-pay what has been lent to you.

Start-Up loan Scheme

Launched in?2012, the government?launched their start up loan scheme, pledging ￡151 million to help entrepreneurs set up businesses in the UK. The scheme’s mission is to provide entrepreneurs with the necessary tools, resources and finance to create thriving businesses in all sectors of the UK economy. Rather than being a loan to the business, this is a loan personally to the budding entrepreneur to inject into their fledgling business.

Loan amounts are between ￡500 and ￡25,000 and have a maximum re-payment term of 5 years. Interest rate is competitive at 6% fixed. The applicant can apply via the government’s website - Apply for a Start Up Loan for your business - GOV.UK (www.gov.uk) and will need to provide a detailed business plan and cash-flow forecast. There is also the benefit of being paired up with a business mentor for the first 12 months.

This government-backed scheme is an excellent option for entrepreneurs, making it easier for entrepreneurs to access the funding they need to get their venture off the ground. Not only does the scheme offer reasonably priced funding, but the free mentoring offers invaluable support, providing new business people with the help and guidance that they need to make the best success of their venture.

Small Business Grant

There are a few start-up business grants available to new UK companies specializing in innovation across a number of fields, from technology to the arts.?The Government’s website (Innovate UK) - Innovate UK - GOV.UK (www.gov.uk) offers financial assistance to start-ups working on ground-breaking inventions with commercial potential. There are also regular competitions awarding funding to start-ups with game-changing ideas, which are all collated on the Innovate UK website.

To find out what local grants are presently available, it’s best to search your borough’s small-business grants schemes, as many local authorities offer funding to start-ups launching in the area.

Crowd funding

This is a very popular way of attracting start-up funding in the UK at the present time, albeit modern crowdfunding is now over 20 years old. For fans of rock music, you may be surprised to hear that it was UK band Marillion who kicked off the trend for crowd funding – raising money from their US fan base to fund their tour across the pond back in 1997. Crowd funding enables start-ups the chance to not only raise money but also generate publicity and gauge interest in a product and develop it as the business grows. There are 2 types of crowd funding in essence, consumer-focused crowdfunding and investor-focused crowdfunding.

Consumer-focused crowd funding

Product-based businesses can benefit from this as it effectively offers a way of ensuring a good number of guaranteed sales even before manufacturing begins. As the investor’s ‘reward’ is the product itself this has the advantage of keeping ownership/share capital with the founder. Clearly there is a cost of producing and distributing your backers’ rewards, so this should be factored into the pricing structure.?Platforms for this type of crowdfunding include Kickstarter (Kickstarter in the UK — Kickstarter) and Indiegogo (Crowdfund Innovations & Support Entrepreneurs | Indiegogo)

Investor-focused crowdfunding

This type of crowd funding involves releasing part ownership of your business and will tend to suit businesses which are not necessarily product-based and those small businesses which need to raise large amounts to expand. Platforms include Crowdfunder (Crowdfunder UK - Where Ideas Happen | Crowdfunder UK), Crowdcube (Crowdcube | Funding the wonderful | Crowdcube) and Seedrs (Invest online in startups via equity crowdfunding | Seedrs)

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Peer-to-Peer Business Loans

A good alternative to the large banks who don’t as a rule readily provide start-up funding to businesses that haven’t yet proven themselves.?

Peer?to?Peer?(P2P)?Business?Lending?provides?business?loans?from individuals, businesses, and institutions, generally through online platforms. They are an alternative to bank loans and can offer a different funding product with significantly shorter decision lead times. The first P2P lender in the UK was Funding Circle (Funding Circle: Fast, Affordable Small Business Finance) , who provide funding up to ￡500,000. Rates tend to be a little higher than the traditional bank – dependant on risk profile can be in double digits.

Angel investors

Angel investors are wealthy individuals looking to invest in start-ups at their earliest stages. Many angel investors have launched a successful business of their own. While you can always approach an investor one-on-one, it’s usually a better idea to pitch your start-up to an angel-investment network.?Examples of angel networks include – The StartUp Funding Club (Startup Funding Club | StartUs), Angel Acadame (Angel Academe), Anglia Capital Group (Home | Anglia Capital Group).

Venture capital

Venture capital (VC) is a form of private equity financing that is provided by venture capital firms or funds to start-ups, early-stage, and emerging companies that are considered to have high growth potential or who have already shown high growth. Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful. Because start-ups face high uncertainty, VC investments have high rates of failure. The start-ups are usually based on an innovative technology or business model, and they are usually from the high technology industries, such as information technology (IT), clean technology or biotechnology.

A venture capitalist is an investor who funds small start- ups with very high growth potential. Almost every notable start-up success story involves a VC, but this form of funding is rarer than most and usually only possible for companies that are expanding very quickly, or that have already had a round of seed funding from angel investors.

A venture capitalist also plays a large role in the operation of the company, becoming associates or partners. Understandably, many start-ups are not amenable to the idea of surrendering a great deal of control over the direction of the company so early on and attracting this kind of investor can take up huge resources of time and energy. The?British Venture Capital Association?provides a directory of venture-capital firms operating in the UK.

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Debt Financing?

Debt-funding can be a great source of investment ‘capital’ for a start-up, partly because it does not dilute the founder’s equity as some forms of funding detailed above eg Venture Capital do.

Certainly, debt funding can be relatively expensive for start-ups. ?Some institutions flat out refuse to lend to early-stage businesses because they consider them too risky. But there are still several debt-financing facilities that could provide the capital needed to reach the next stage of growth.

Funding from Bank’s for start-ups tend to primarily be via overdraft/commercial cards for working capital needs and loan (up to 10 years in term) for capital expenditure – such as new equipment purchase. Many of the Bank’s for start-ups will use credit scoring to assist them in assessing the ability to support with funding. The credit score will consider the type of business being set up, the purpose of the funding, the element of founder/friends and family ‘stake’ in the enterprise and if applying via your personal bank, the behaviour exhibited on personal account (whether any overdraft limit has been exceeded, the turnover going through the account).?The institution will look to find out the following from the applicant: -

·??????Details of the founder (owner occupier/tenant, married/single, experience, qualifications) and the business (industry, location, market, suppliers).

·??????Personal/business investment – level of founder investment v the Bank (preferably 50/50).

·??????Purpose of the funding applied for eg working capital (paying suppliers before payment received from customers) and capital expenditure.

·??????Amount – to determine if the amount being applied for is appropriate and to help structure the borrowing in the most appropriate way i.e., Overdraft v Loan.

·??????Term – the time over which the borrowing is required – this will help the Bank assess the finance options and the ability to repay the amount borrowed.

·??????Repayment – to understand how the entrepreneur intends to repay the borrowing and be confident of the ability to do so. For a start-up business this can be detailed in a business plan including a cash flow forecast and income and expenditure statement (over at least the first 12 months). Established businesses can be assessed against historic trading figures as well as plans and projections.

Interest rates and Arrangement Fees will vary between institutions and the amount of the facility. Security or collateral as it is sometimes known for Limited companies will usually take the form of a personal guarantee from the founder (potentially backed-up by a charge over the home) and a Debenture.

During the COVID19 pandemic the Bounce Bank Loan (provided via institutions and guaranteed by the government) and its big brother the Coronavirus Business Interruption loan (CBIL) were widely used by early-stage businesses. These schemes have now finished and have been replaced The Recovery Loan Scheme (RLS) from 06 April 2021 (Recovery Loan Scheme - British Business Bank (british-business-bank.co.uk)) available through the majority of the high street banks.

Another type of debt funding available for early-stage businesses is Venture debt - a type of debt financing tailored to start-ups and other venture-backed growth companies, provided by specialist lenders eg Boost & Co (Tailored venture debt solutions for high-growth businesses | BOOST&Co (boostandco.com))

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Unlike other forms of financing, venture debt is not dependent on collateral or a company’s cash flow. Instead, lenders prioritize the ability to continue growing and raise additional investment capital, thereby enabling the business to repay the loan.?

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In some cases, lenders will provide venture in exchange warrants, which lets them purchase equity in the business at a guaranteed price over a set period. As the company grows, these warrants increase in value, creating larger returns and a bigger incentive for venture debt lenders.

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Venture debt could let the business owner raise additional investment capital quickly and without significant dilution to the company’s equity.

Most businesses will not rely on one source of funding and will use a combination of some/potentially all the above during their early stages of growth. For further information about some of the types of funding detailed, please do contact me.