5 business funding options every small business should think about

Business funding options

For most businesses, access to cash is an almost constant worry – whether that be the need for a big injection, like a substantial loan, or a smaller top up of money to keep you going through a rough month or two.

And a big part of that stress is not knowing or understanding the options, what you might be eligible for, how long it might take to get and what the process even is.

There’s an overwhelming amount of information out there, but it can be hard to know where to begin.

To help, we’ve rounded up five of the key funding options with everything you might need to know. Jump straight to the type of finance you’re most interested in or read on to hear about all of the options…

1. Business term loans
2. Business line of credit
3. Invoice financing
4. Merchant cash advance
5. Business credit card

1. Business term loans (or traditional loans)

When most people think of borrowing finance, they’re probably imagining a traditional loan model.

What is a business term loan?

A traditional loan is referred to as a business term loan – primarily because you’re committing to borrowing a set amount of money, over a particular term, or time period.

You apply for a loan through an individual lender and they set out specific conditions, such as the overall loan amount, interest rate and time period – and therefore what your monthly repayments will be.

Loan repayment times vary from around 18 months to up to five years. Interest rates are also variable and are often dependent on your particular credit history. To give you a rough idea, if you have strong credit interest rates are normally around 6-8% for a business loan (although they can be as low as 4%).

Typically, a longer repayment term may give you a lower interest rate, but you’ll need to bear in mind that you may ultimately end up paying more in total as you’ll be paying interest for an extended time period.

The difference between secured and unsecured business loans

Another key thing to bear in mind is the two main different types of business term loans.

A secured loan

To qualify for a secured loan, you’ll need to have some substantial assets – such as property or machinery – that you could potentially sell if you can’t manage your repayments (your loan is ‘secured’ against these assets). Lenders use this collateral to incentivise borrowers to pay in a timely manner. You can normally secure a slightly better deal as it’s a less risky proposition for the lender, but it’s not an option for every business.

An unsecured loan

One of the problems for small business owners is that you may not have had a chance to build up a solid credit history for your company – or you might not have the necessary assets mentioned above. If this is the case, an unsecured loan could be perfect as it focuses on your current relationship with money rather than your history.

To qualify you’ll just need to have been UK registered for at a minimum of six months and have at least some turnover (a few thousand per month).

Is a business term loan right for your small businesses? Key things to consider:

Lump sum – you get a potentially large injection of cash direct into your bank account
Timing – a straightforward application can be turned around quickly (usually within 10-14 days)
Flexible – you can use the money on varying expenditures
Cost – loans can work out costly if the interest rates are high, which can be particularly true for small business owners who haven’t built up strong credit
Overall interest – You may be required to pay interest on the entire loan amount. In some cases you settle early and save on interest

Best used for:

Buying assets
Growth and expansion

Business owner example

Sam Brown needs to borrow £150,000 for his plumbing business. His business has been running for three years and he has a solid credit history and several company vans so is eligible for a secured loan. He approaches a lender who agrees to lend him the full amount over five years, with an interest rate of 6%.

Amount needed: £150,000
Monthly repayments: £2,899.92
Term: 60 months
Interest rate: 6%
Total amount repaid: £173,995.21
Typically, Sam will need to provide: The last set of filed accounts, three months business bank statements and details of all directors and shareholders.

2. Business line of credit

While a business loan is great for big expenditures, if you’re looking for access to working capital more generally (cash for day to day operations), then a business line of credit could be a better – and more flexible – solution for you.

What is a business line of credit?

Unlike a loan, where you borrow a set amount over a fixed time period, with a line of credit you will be approved – via a lender – for a credit line that you can ‘draw’ against, as and when you need it. This also means you only pay interest on the actual amount you spend.

Within the limits of your terms, you set the amount of money that goes into your account and when, a bit like spending on a business credit card. Occasionally companies will have specific ‘draw’ periods and ‘repayment’ periods, but generally you are able to access funds whenever you need them.

In contrast to a business credit card, the amount you can borrow is normally significantly larger, up to £200,000 and in some cases even more.

As with business loans, some credit lines may need to be secured against any existing assets.

Is a business line of credit right for your small businesses? Key things to consider:

Typically you only need a year’s trading
Access cash on an ongoing basis
You only pay interest on what you use, although this isn’t the case with every lender
Interest rates are normally higher than they are for a business loan
It’s typically designed as a 12 month facility

Best used for:

Managing cashflow
Purchasing stock
Hiring staff

Business owner example

Sandeep Singh runs a marketing agency. He needs to get some new equipment for his growing team. The amount he needs isn’t completely fixed as he’s still in the process of hiring a number of new team members. He anticipates he may need up to £30,000.

Amount needed: £30,000
Monthly repayments: £2,931.08. The monthly payment is dependent on how much you have outstanding. For example if you paid off £10,000 and then had 9 months and £20,000 remaining left to pay, your monthly payment would drop to £2,512.77
Term: 12 months
Interest rate: 1.5% per month
Total repaid: (this is dependent on how you use the facility)
Typically, Sandeep will need to provide: The last set of filed accounts, three months business bank statements, VAT Returns and details of all directors and shareholders

3. Invoice financing or factoring

A big pain point for a lot of businesses is long invoice terms, you could be waiting anything up to 90 days to be paid – which can cause a real cashflow headache.

If your small business regularly invoices customers, you may have the option to borrow finance against the value of these invoices (to help bridge the gap while you wait to actually be paid them).

What is invoice financing?

Invoice financing is used to describe the process of a third party ‘buying’ your unpaid invoices, for an agreed cost. Predominantly financiers will buy business to business invoices, rather than business to consumer.

Traditionally, invoice financing works in two ways, invoice discounting and factoring.

Invoice discounting operates a bit like a business overdraft. The financier will lend you money against the value of your invoices (normally an agreed percentage of the total amount), for which you will pay a fee, often starting at around 0.5% of the invoice value. It can be arranged confidentiality so your customers won’t be aware.

As a business, you are still responsible for chasing the invoices and collecting the debt.

Factoring operates differently in that all of your trade debt will be managed by the financier. They will manage your sales ledger and collect payment for you. This means your customers will be aware you’re using invoice financing.

Within about 48 hours, the financier will make a percentage of the invoice value available to you as a business. They will then collect the total debt amount from the customer, which they’ll then pay you, minus interest and a potential fee. How much you’ll be charged depends on the funding provider and your credit and trading history.

Is invoice financing right for your small business? Key things to consider:

Immediate access to cash
Can often borrow more than via a traditional loan or overdraft
For a small business, factoring can help alleviate the pressure of having to chase invoices yourself
You will likely have to commit to a contract with a minimum term of 12 months
If you use factoring, your customers will know you’ve borrowed against their invoices, which can impact their perception of you
Will the facility amount be enough to service your growth plans?

Best used for:

Cashflow shortfalls

Business owner example

Alexis Maritz is running a book publisher. She often experiences cashflow shortages as there is a big time lapse between paying the book printers and suppliers and any book being released and sales revenue coming in.

To help manage this, she recently borrowed via invoice financing with a facility amount of £300,000.

Facility amount: £300,000
Percentage against invoices: 80% (this means if you have a £100,000 invoice, you could borrow £80,000 against it and £80,000 would come off your available credit line. In this case you would minus £80,000 from the £300,000 line leaving £220,000 available)
Monthly fee: Dependant on how much you use
Annual cost: £8,342.00 (this is the minimum cost you’ll pay)
Typically, Alexis will need to provide: She would need to make an appointment with a lender to do a full review. They will need financial information (accounts, bank statements, aged debtors) to make a final offer. They will also need to verify the invoices you have raised before completing the facility.

Merchant cash advance

A merchant cash advance is a fairly new form of alternative financing. It’s particularly useful for retail and leisure businesses – or basically any business that has a high level of card transactions.

What is a merchant cash advance

In the same way that businesses can borrow from their ‘owed’ invoices, for a merchant cash advance, a lender will assess your card terminal transactions as a basis for lending you money.

The lender will work directly with your card terminal provider to get visibility on your transactions – therefore getting a sense of how much money is coming into your business on a monthly basis.

It’s a great option if you don’t have a lot of material assets, or a long trading history, as it’s about the money coming in right now. In addition, as a lender can see your financials quickly, a loan amount can be agreed much faster than some more traditional options.

A merchant cash advance loan is typically around one month’s card takings and repayments are made as a percentage of your revenue, and taken directly from your card sales (which is useful as you can pay more when things are going well and less when money is a bit tighter).

You will also pay a funding fee which will vary by lender.

Is a merchant cash advance right for your small business? Key things to consider:

Access to cash fast
Flexible repayments that adapt with revenue
It’s only suitable if the majority of your revenue comes via card sales
It’s a fairly short term solution
Will the percentage of each transaction taken effect your cashflow?

Best used for:

Purchasing stock
Alleviating cashflow issues

Business owner example

Funmi Olatoye runs a children’s clothes shop. It’s a fairly new business but trade has been really good since it opened. She needs access to some funds in order to purchase more stock.

As the majority of her sales are processed via card transactions she applied for a merchant cash advance.

Cash advance: £25,000
Percentage fee: 15% of each transaction
Typically, Funmi will need to provide: Accounts, bank statements, merchant statements and directors details.

5. Business credit card

While most people will have experience using a credit card for personal reasons, you might not be familiar with the terms of a business credit card, and how best to use it for your funding needs.

What is a business credit card?

In the same way that the limit you get on a personal credit card is determined by your credit history, for a business credit card you will be assessed on your firm’s turnover. This normally means you can borrow more with a business credit card than a personal one.

If you use it effectively, and avoid any late payments, it can be a useful way to build a credit history for your business – which could help you get further funding down the line.

You are not limited to just one business credit card, although providers will take this into account and it may impact your application if you have too many other cards already.

Interest rates and fees are often higher on business credit cards than they are on personal ones, which means if you can’t clear your balance immediately they can get quite costly.

Is a business credit card right for your small business? Things to consider:

Immediate access to cash
Can build business credit
Can have multiple cards linked to one account to give to members of your team
Fees and interest can be quite high

Best used for:

Purchasing equipment or stock
General expenses
Paying invoices

Business owner example

Mike Chandler runs an advertising agency where entertaining clients is a key part of building relationships. A business credit card means a few of his account managers can each have access to a card to cover expenses.

Amount needed: £25,000
Monthly repayments: Usually around 10% of outstanding balance
Term: ongoing
Interest rate: Variable depending on your terms

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