Every new business needs money when starting up. For the majority of businesses, equipment will need to be bought, the workplace established and marketing costs met - all before the first sale is made. Then once you’re trading, you’ll need cash to pay the bills and keep the business going.

There is a range of financing options. Choosing the right ones for your needs is essential. You can use your own money, borrow from banks, family and friends or attract outside investors. Grants and government support may also be available.

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

When starting your business, you need to put together a business plan. This plan sets out how you intend to operate your business and includes essential financial forecasts. These forecasts will help you determine how much funding the business is likely to need, what you need it for and when you will need the money. Good planning will also make it easier to raise the money you need. Use your business plan to explain your business to your bank and other potential sources of finance. A good plan helps convince them that you know what you are doing, and that it is worth risking their money backing you.

It’s essential to have an accurate idea of your financial needs. Once you’ve calculated the amount you’ll need to cover your initial start-up costs, you’ll also need to factor in your running expenses. 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.

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.

• Many people use their own savings or personal borrowings to fund the business. This may be the only choice if you can’t convince anyone else to lend you money or invest in the business.
• Family or friends might back you. However you should carefully consider the risk that they could lose their money if your business fails.
• If you have a credible business plan, you may be able to borrow from a bank. Many businesses use overdrafts for day-to-day borrowing and loans 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.
• A larger business with good prospects might attract outside investors. For example, “business angels” typically invest £10,000 or more in exchange for a share in the business.
• You might qualify for a grant - for example, if you are setting up a business in a deprived area.
• If your business is setting up in a deprived area, or in a sector that is not normally catered for by mainstream lenders, you might be able to attract finance from a community development finance institution. Alternatively you might be able to attract support from other businesses in your peer group.

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

Set up your business on your own money

If you’re starting a new business, it’s likely that you’ll have to put up some of the money yourself. In fact, it’s usually difficult to borrow from a bank or attract other investors unless you’re investing some of your own money. The easiest way to provide your own financing is if you have savings you can use. If not, you’ll have to think about other possibilities, such as:

• getting a mortgage, or second mortgage
• borrowing privately
• getting an unsecured loan, or borrowing on credit cards
• selling possessions or assets

You should think carefully before borrowing to finance your business and should match the financing to your needs. For example, using credit cards for long-term expenditure can be cripplingly expensive while some loans can be inflexible - you could end up paying interest over many years. Don’t over-extend yourself. If you borrow too much, you may not have enough money left 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.

Advantages: Self-financing your business gives you far more control than other finance options. Outside investors or lenders could decide to withdraw their support at any time and most will expect a good return on their investment in the form of interest, shares or dividends.

Disadvantages: You must be aware of the risks. If your business fails 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.

Friends and family may help to start your business

If you can’t raise enough money yourself to start your new business, your friends and family may be willing to help. They might lend money to you or to your new business or they might invest in your business, eg by buying shares.

You should provide potential investors with an up-to-date business plan. It will help demonstrate how their money will be used and explains the long-term plans for the business. You should also make sure that you have a written agreement in place that sets out terms and conditions, including any interest and repayment terms. This should help avoid misunderstandings.

There may also be tax implications for you and your family, especially on interest-bearing loans.

Advantages:

• Friends or family may be more willing to lend you money than a bank, particularly if you cannot provide security for a loan.
• Friends and family may offer easy terms - eg an interest-free loan.
• If you can raise some finance from your own resources or friends and family, it should make it easier to get additional finance from the bank.

Disadvantages: You need to be careful. You may feel under personal pressure, particularly if your business starts to struggle and there’s a risk that friends or family will lose their money. Remember that they too may worry about their money and this may put a significant strain on your relationship. As a rule of thumb, you should never ask them to lend you more than they can afford to lose. You should also seriously reconsider whether your business is a viable prospect if traditional lenders such as banks are unwilling to lend you money to start up.

Borrow from a bank

Overdrafts and bank loans are the most common sources of additional finance. Before lending, a bank will want to know that you are a good risk. Typically, the bank will want you to:

• present a credible business plan
• provide evidence that you have a successful track record in business
• offer security for any money it lends you - either business assets or a personal guarantee
• invest some money in the business yourself

If you don’t meet all the bank’s normal requirements, you may qualify for a loan under the government’s Small Firms Loan Guarantee (SFLG) scheme.

Whatever type of borrowing you use, you may have to pay arrangement fees as well as interest. Many small businesses use an overdraft to cover their borrowing needs. If you need longer term financing, it’s a good idea to consider taking out a loan.

Always take advice from your accountant or business adviser before signing any agreement to ensure the loan meets your requirements and you understand the terms.

Outside investors

You might want to bring in outside investors. If the business does well, they share in the profits - but if the business fails, they lose their money.

Typically, your company issues ordinary shares (standard shares with no special rights or restrictions) to investors in return for their investment. Outside investment can suit promising businesses that do not expect to produce a lot of spare cash in the short term but offer the potential of greater returns over the longer term.

Advantages:

• Attractive for businesses looking to bring in additional expertise as well as funding.
• Unlike loans and overdrafts, you do not normally have to make payments to investors until the business can afford them.
• Increasing the capital invested in the business makes it easier to borrow from the bank.

Disadvantages:

• Your share of the business, and of its profits, will be lower.
• Investors may want control over how you manage the business.
• Investors may want the business structured in a way that makes it easier to sell their shares in the future.

Sources of investment:

There are several different sources of investment:

• individuals, such as friends and business contacts
• business angels
• investment funds and venture capitalists for larger investments

Business angels are wealthy individuals who typically invest £10,000 upwards and may also offer business expertise. Venture capitalists usually invest more than £2 million in businesses they believe will provide a high earning potential and a defined exit time.

Before approaching potential investors you need a good business plan, including evidence of your management ability. Your plan should include detailed financial forecasts and demonstrate what you will do with funds invested in the business. You will also need to prepare a pitch, which will sell your business to potential investors.

Grants and government support

Your business may qualify for a grant or government support to help you get started.

The main advantage of grants is cheap financing. For example, you might get a subsidised or zero-interest loan, or even an outright cash grant. In addition, support schemes can provide expert advice, information or subsidised consultancy.

However there are drawbacks:

• there is strong competition for grant schemes
• you must meet the scheme’s criteria - such as business location and size, and how you plan to use the money
• the application procedure can be complex and drawn out
• you normally have to use the grant for a specific project, rather than general business costs
• grants usually only cover a percentage of the costs - you also have to provide matching funds

The Small Firms Loan Guarantee scheme helps businesses that would not normally qualify to get a loan.

Other sources of finance

Many start-up businesses do not require a great deal of money to get up and running. These small amounts of finance - known as micro finance or micro credit - are often not available through traditional lending sources. If your business is setting up in a disadvantaged area or a sector that is typically underserved by mainstream lenders, you may be able to source finance or support from one of the alternative sources of micro finance. These include community development finance institutions (CDFIs) or through other companies in your peer group.

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.

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.
• 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.
• 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.

Tags: finance