Financing a startup
Be as detailed as you can with your financial planning. Start by asking yourself:
- What will your start-up costs and ongoing costs be?
- Do you have this money already or will you need to borrow it?
- How much money must the business make each week and month to cover your personal and business costs?
- Are you are prepared to be out of pocket while your business is building?
- How much will you charge for your products or services?
You will need to bookkeep, monitoring your income and expenditure from day to day. You can use this to compare progress against your original plan and produce more accurate forecasts.
Once your business plan is done you’ll have some idea of whether or not you have the resources to fund your business or if you will need to borrow or find other sources of finance.
When formulating your financial plan, choosing where you will work from could have a big impact on your initial costs. Can you set up an office at home or will you need to find separate premises? You can usually work from home without seeking planning permission as long as:
- the look of your home doesn't change significantly
- the business doesn't become the first purpose of the property
- you don't cause inconvenience to your neighbours.
Always check with your home insurance company about running a small business from home to make sure you’re covered.
If your business has grown and you need more space, think hard before renting a large or long-term property, especially when you're just starting out. Serviced offices are a useful option – they can be more expensive but give you more flexibility.
How much finance you need will depend on the nature of your business. In the beginning, your own money or funds from family and relatives will often help kick things off. As the business gets going, you may start looking to introduce other ways to manage your cash flow, such as an overdraft facility.
If you have the money, you can of course continue self-funding. This has advantages because it means you won’t be paying interest and will still have full control over the business. However, once your money is invested in the business it means you won’t have access to it yourself as a contingency. You will need to make sure your business has access to sufficient cash from elsewhere to keep going if you face any cash flow issues.
Self-investment is sometimes done in the form of a loan: the director of a company lends money to their own business, and then takes it out again later, instead of wages. If you are considering this, always talk with your accountant first.
How useful asset finance may be to you will depend on the nature of your business. If you need vehicles or machinery, asset financing may be a potential solution. The asset itself can sometimes be used as collateral, which reduces the risk for the lender. It also avoids the need to acquire the assets with cash. Instead, you fund the purchase over an agreed period of time, which protects your cash flow. Other financing of this type includes contract leasing and hire purchase.
While banks generally work with established businesses this doesn’t mean start-ups are excluded from bank funding. Banks tend to base loan decisions on the individual’s application. Your personal credit record and experience will be considered. The bank will often want to see that you have confidence in your own venture by committing your own money, and therefore have a personal stake in its financial success.
You may be asked to put up collateral or security for the loan, for example equity that you have in your own home. Usually what the bank lends a small business is not in return for an equity stake in the company so you will keep full control.
Understandably, banks may want to keep an eye on their loans to some degree, perhaps by asking you to supply management accounts or regular cash flow forecasts.
Depending on your business type and sector, you may also be eligible to apply for government grants. Grants are often aimed at not-for-profit businesses, but other companies can sometimes benefit as well.
There are also a wide range of government enterprise schemes offering grants, guarantees or alternative sources of finance.
The British Business Bank channels government funds into making start-up loans available to small businesses. It can also provide a guarantee to the bank on your behalf through the Enterprise Finance Guarantee Scheme.
Be warned though, the grant application processes and other government schemes can take time and contain additional fees or commitments. Also, the eligibility criteria may not align with your planned business direction. If you want to have a chance of qualifying, this may mean that you have to shift your planned offering away from its original focus.
Third-party equity investors
Some business ideas may need research and development, like creating new software or an online service. If this is what you want to do, you are likely to need equity investment. Banks generally don’t get involved in this type of funding and alternative lenders are unlikely to provide sufficient capital.
There are various types of third-party equity funders offering investment into your business in exchange for a share. The upside is there’s no immediate interest payment, and such investments may also bring with them expert advice and support. But you will no longer be the full owner of the business. If your business is successful, the equity you’ve given up could become costly to buy back again and regain full control.
Business angels, venture capital firms (VCs) and independent investors come in at different stages of the business cycle. Angel networks and individual investors buy-in early, but usually want more equity because they are taking a higher risk. However, they are often sophisticated investors with a passion for your sector, so you can also benefit from their experience.
VCs look for better-established businesses with potential for higher, long-term growth. They invest with the intention of getting out over a relatively short time period. VCs can provide significant funds to the right businesses for their profile, and can provide access to expert advice, mentors and a network of contacts. The caveat is that you will be giving up an element of control, and VCs may even intervene if they are unhappy with the emerging direction of the business.
Other types of equity investments include crowdfunding platforms, peer-to-peer lending and peer-to-business lending. The principle is for third parties to front the cash through a fund or other investment vehicle in exchange for a return, not necessarily equity.
When considering your funding options, it is crucial you understand what the return on any investment will be and how that will work for you when you account for borrowing costs. Make sure these are fed back into your business plan and that the plan is still workable.
Many start-up owners struggle to escape the day-to-day pressures of running a business and don’t think strategically about the impact of funding on their growth, until the situation becomes urgent. But if you intend to make well informed decisions about the business, it’s vital to step back and take in the bigger picture from time to time.
Much depends on you, the business owner – your attitude, the type of business you want to start and what you want to achieve. But on a very practical level, much also depends on an informed, proactive approach to business funding – whether there is going to be enough cash to get the business off the ground, to safely navigating those all-important early stages and stay afloat in times of adversity.
You can find advice and guides to help you understand and identify suitable finance options for your business. You can find government-backed start-up loans that also offer 12 months mentoring to successful loan recipients.
A free and independent source of information on the forms of finance available to business owners, management teams and their advisers.
Finance and support for your business from GOV.UK
Information about support and grants you can get all around the UK that might help your business.
Guidance on setting up a company from GOV.UK
Finance advice including writing a business plan, tax and registering and how to grow your business on the government website.
While all reasonable care has been taken to ensure that the information provided is correct, no liability is accepted by Bank of Scotland for any loss or damage caused to any person relying on any statement or omission. This is for information only and should not be relied upon as offering advice for any set of circumstances. Specific advice should always be sought in each instance.