Choose the right finance when starting up

Every new business needs money when starting up. The majority of businesses will need to buy equipment, establish the workplace and meet marketing costs – all before the first sale is made. Once you’re trading, you’ll need cash to pay the bills and keep the business going.

There are a range of financing options when starting up and choosing the right ones for your business needs is essential. You might be able to use your own money, or you may need money from an external source or investor – eg from banks, family and friends or outside investors. You may also be eligible for grants and government support.

Most businesses use a combination of these alternatives, according to their specific needs and circumstances.

This guide will help you to work out how much money you need for setting up your business, the various financing options available for your business and their advantages and disadvantages.

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Work out your financial requirements when starting up

When starting a business, you need to prepare a business plan. This should set out how you intend to operate your business and should include essential financial forecasts. These forecasts will help you determine how much funding your business requires, what it is needed for and when you will need it by. For more information, see our guide on how to prepare a business plan.

Good planning will also make it easier to raise the money you need by showing potential investors that you know what you are doing and that it is worth investing in your business. See our guide on how to use your business plan to get funding.

How much finance do you need – and when?

It’s essential to have an accurate idea of your financial needs. Once you have calculated the amount you’ll need to cover your initial start-up costs, you’ll also need to factor in your running expenses. You should also remember that customers may not pay you immediately – but you will still need to pay all your bills to keep trading. It’s sensible to have sufficient capital to cover projected expenses for at least six months.

At the same time, you need to make sure that you have taken into account how much money you need to live on. In the early stages, a new business is unlikely to produce spare cash that you can spend on yourself. For more information, see our guide: how do I survive until my business is off the ground?

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Finance options for new businesses

The type of finance you choose will depend on what kind of business you are starting, how much money you need and what you will use it for. For example, you could:

• Use your own savings or personal borrowings to fund the business, particularly if you can’t obtain finance or investment from external sources – see the page in this guide on how to use your own money to set up your business.
• Borrow money from family or friends. However you should carefully consider the risk that they could lose their money if your business fails – see our guide on financing from friends and family.
• Borrow from a bank if you have a credible business plan and can offer some security. Many businesses use overdrafts for day-to-day borrowing and to manage cashflow, and loans for long-term funding, or to finance large purchases such as equipment. If your business is likely to have peaks and troughs in its cashflow, it’s essential to be able to clearly illustrate these to your bank so you can plan an overdraft. When considering bank finance, it is generally a good idea to take professional advice from your accountant or business adviser.
• Aim to attract outside investors – eg by selling shares to business angels or venture capitalists. This can provide short-term finance without the need for repayment, and can also bring in expertise along with funding. However, it usually means giving up shares in your business, and investors may want some control over its management. See our guides on shares and shareholders and equity finance.
• Qualify for a grant or government support. These can provide very cheap financing, and often come with business advice or subsidised consultancy. However, there is usually a lot of competition for grant schemes, and you will need to meet various criteria – depending on the scheme. See our guide on governemt support for businesses.
• If you are finding it difficult to obtain bank finance, you could also consider commercial lenders – such as insurance companies and building societies. You may get a better deal – eg lower interest rates – and they are generally less restrictive – eg if you have a poor credit rating. However, commercial lenders are also subject to fewer regulations than banks and you may have to provide some security in order to obtain funding. 
• Look for finance from other areas – eg from a community development finance institution – if your business only needs a small amount of funding, or if you are setting up in a deprived area, or in a sector not normally covered by banks or other lenders. See the page in this guide on other sources of finance.

Most businesses use a mixture of finance sources. For example, you might invest your own money to cover market research, bring in outside investors to share the risk and borrow from the bank to purchase equipment and machinery.

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Use your own money to set up your business

If you’re starting a new business, it’s likely that you’ll have to put up at least some of the money yourself. In fact, it’s usually difficult to borrow from a bank or attract other investors unless you’re also investing some of your own money.

The easiest and most cost-effective way to provide your own financing for a new business is to use your own savings. However, this can be risky, and you may not have enough to cover all the funding you need. You could also consider

• getting a mortgage – or a second mortgage
• borrowing privately – see our guide on financing from friends and family
• getting an unsecured loan, or borrowing on credit cards
• selling possessions or assets

You should always think carefully before borrowing any amount of money and should always aim to match the financing to your needs. For example, using credit cards for long-term expenditure can be very expensive, while some loans can be inflexible – you could end up paying interest over many years.

Its also important not to over-extend yourself. If you borrow too much, you may not have enough money left over to cover your living costs while the business gets going. You should also try to leave a contingency fund, in case you need extra money to see you through a difficult period.

Self-financing your business gives you far more control than other finance options. It also means that you don’t need to pay back or rely on outside investors or lenders, who could decide to withdraw their support at any time.

However, you must be aware of the risks of financing a new business yourself. For example if your business were to fail, you could lose your home and other personal possessions. And just knowing how much you have borrowed can put a lot of pressure on you and your family.

It’s always a good idea to take professional advice before making a final decision on financing.

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Other sources of finance

If you are finding it difficult to obtain finance from the normal sources – eg from a bank or investor – there are more options to consider, for example:

• community development finance institutions (CDFIs) – can provide finance to businesses who only need a small amount of funding and who can’t obtain it from banks or other lenders
• peer group lenders – are organisations that specialise in providing funding and business support to business owners of a particular age or background, or for businesses of a certain size or type
• as a new business, you may be eligible for tax breaks – eg lower tax or National Insurance contributions rates

CDFIs

CDFIs are sustainable, independent organisations established to develop and create wealth in disadvantaged communities or markets. They provide capital and support to individuals, micro enterprises and small businesses.

A loan from a CDFI can be used to purchase equipment or property, to finance working or start-up capital or to fund marketing campaigns. Loans can be for as little as £50 or up to £1 million depending on the project. Find out about CDFIs on the Community Development Finance Association website- Opens in a new window.

Peer group lenders

Some businesses find that they can access finance, support and advice from other businesses in their peer group – known as peer-group lenders. There are many organisations that have been set up to support specific groups of individuals and businesses. These include:

• Prowess – the UK association of businesses and individuals that specifically support women in business. Find out about the support available to women in business on the Prowess website- Opens in a new window.
• The Asian Business Development Network (ABDN) Ethnic Minority Enterprise Network – assists Asian and minority businesses by creating access to opportunities and sharing best practice. Read about the Ethnic Minority Enterprise Network on the ABDN website- Opens in a new window.
• The Black Business Initiative (BBI) – aims to support the black and minority business community. Find information on the services provided by the BBI on the BBI website- Opens in a new window.

See our guide: is there extra help and support available for your SU.

Tax advantages for new businesses

As a new business, you may also be eligible for tax allowances and reliefs – see our guide on tax advantages for those starting up in business.

New businesses may also be able to benefit from the government’s Regional Employer NICs holiday scheme. This may entitle you to a reduction in your NICs. For more information, see our guide on regional employer NICs holiday for new businesses.

For more information about raising finance for your business, see our videos about understanding business finance on the Business Link YouTube channel- Opens in a new window.

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CASE STUDY

Here’s how I found the right sort of finance for my new business

Mimimyne, a London-based online retailer of eco-friendly children’s products, started trading in September 2008. The company’s managing director, Tabitha Potts, wanted her business to have a high-quality website to reflect the design and workmanship of the products she planed to sell. Here Tabitha explains how she found the finance she needed to set up her business.

WHAT I DID

Considered all options

“I researched every option and looked into a range of different sources of finance. I’ve worked as a researcher, so I’m good at finding information and sifting through it quickly. I did it all on the internet.

“I didn’t want to approach family and friends because I was looking for about £10,000, which I thought was an awful lot to ask for. I also didn’t want to mix my personal and business affairs.”

Searched for grants

“I used the Business and IP Centre at the British Library, which has a grant and funding database, as well as Grantnet or J4B Grants find grants, but I couldn’t find anything suitable for me.

“A couple of them offered small sums, while others were either for small charities and social enterprises, or for large companies trying to go green. But I wasn’t eligible.”

Pitched for loans

“I then approached banks. I only wanted to go to an ethical bank, but Triodos and the Co-operative Bank both wanted match funding, which I wasn’t able to provide.

“Next I went to Fair Finance, which offers community loans in my area. They were helpful but I had to offer my house as security and I didn’t feel comfortable with that. I even went to an ethical business angel but I was too small to be considered.

“Then I met with the East London Small Business Centre (ELSBC). I presented to about ten people, but I treated the pitch like a conversation and I knew my financial projections and the figures in my marketing plan.

“I now have a £10,000 loan from the ELSBC through Deutsche Bank. It has to be repaid over three years. They have been very helpful and given me a couple of months’ payment holiday while I set things up.”

WHAT I’D DO DIFFERENTLY

I’d ask for a bigger loan

“I underestimated costs. For example, there were some things I just hadn’t anticipated, such as the cost of going to trade shows where I had to pay for everything, from an awning to price tags.”