Is external finance right for your business?
As 2020 begins, we’ve been reflecting on what the last 12 months looked like for UK SMEs. Many new startups found their feet in 2019 as we saw an increase in entrepreneurship and creative businesses. We wanted to know how these businesses funded themselves, especially with SMEs looking optimistically into the future, predicting fast-paced growth this year.
As it turns out, 42% of SMEs used external finance in 2019, a substantial increase from 36% the year before. In fact, this is the highest level seen to date by the SME Financial Monitor. This percentage increases even further in the case of bigger businesses.
So where are these businesses finding their funding and, importantly, what’s making them choose one option over the other? Let’s take a closer look at the following external finance options:
- The family bank
- Equity investments
- Credit cards
- Invoice finance
- Business loans
- Personal funding
1. The family bank
Starting a business can be an exciting, albeit daunting, time in anyone’s life. Having your nearest and dearest supportive and willing to invest in not only your business but essentially you, can be a welcome proposition.
So it makes sense that so many SMEs choose to source their funding from family and friends. Not only do they know you, believe in you and share your goals, but they can offer you the funds that will either kick-start your business or help it grow when the time comes. This might be the confidence boost you need to really make a go of it.
Although this is a valid option, it can be limiting in the long run. Cash flow may become a challenge as your business takes off. Unless your family and friends have an unlimited supply of money, it would be wise to have an additional source of finance available.
2. Equity investments
Equity investors purchase shares in your business. They provide an influx of cash that will provide your business with the cash flow to invest in itself. The more investors you have, the more your cash flow and value will increase.
Equity investments can strengthen your business financially. It is, however, important to note that you will lose some control when you start selling shares. In a way, you’re selling tiny pieces of your business and you’ll need to make your business and financial decision with your shareholders in mind.
If you have a great idea, and the means to get a whole lot of people excited about it, then crowdfunding might be the thing for you. Crowdfunding is a method of raising funds by getting a mass of people to invest small amounts. This is usually done on an online platform like Kickstarter or Crowdcube.
There are several options to consider from equity-based crowdfunding to reward-based crowdfunding where investors get incentives, gifts and rewards in return for their investment.
4. Credit cards
Credit cards are one of the leading forms of external finance for SMEs. Even though credit cards have not always had the best rap, when used correctly they can be beneficial to a business.
The most important thing to remember here is that the interest rates of most credit cards are higher than a business loan, for example, which would’ve been tailored to suit your needs. Credit cards should only be used for short-term needs and special attention given to the repayment plans.
Like a credit card, a bank overdraft is a pre-approved amount of money that you could use when your account is emptied. Again, this could be useful when your cash flow is constricted. Like when you’re waiting for a payment to come in or when a supplier needs to be paid before your clients have settled their invoices. As with credit cards, the interest can be hefty and you need to be aware of what your repayments and potential losses might be.
6. Invoice finance
Another option to consider when your cash flow is being squeezed is invoice finance. This is a form of external finance that enables you to advance funds against your outstanding invoices. That way you get access to the money that is technically already yours, without having to wait 30, 60 or even 90 days for your clients to pay.
Unlike factoring, you’re not selling your invoices to a third party so you maintain ownership of both credit control and your client relationships.
7. Business loans
There are times when you might just need an influx of cash to grow your business, which is where business loans become invaluable. With the rise of fintech over the last decade, loans can be accessed within 24 hours and with flexible terms tailored to your needs.
Remember, you’ll need to factor the interest rates and repayments into your budget so that you can still manage your cash flow even with this working capital injection.
8. Personal funding
Investing in yourself and your business also saw an increase in 2019. Although this is a great option if you are able, it does carry with it some additional risk. Yes, when you ask an external source to invest in your business, you’re welcoming others into the fold. This might cause you some trepidation but they’ll also help share the risks.
If you do invest in your business with your own personal funds, you alone will carry the risk and this could be a problem if things don’t go according to plan. Make sure that whatever you decide to invest as capital into your business is not causing you to overextend, and that you have an alternative finance option to fall back on.