New as well as mature businesses are always seeking additional funding so as to grow, increase profits, acquire assets or to overcome a cash flow crunch.
Fortunately, the UK has a vibrant and advanced banking and investment climate which caters for nearly all types of funding that businesses require. The challenge is identifying the right funding provider and the right type of funding for the business.
The types of funding available to entrepreneurs include:
• Grant funding
• Debt funding
• Equity funding
• Self-funding (either in the form of equity or debt)
Grants are normally awarded by governments and quasi-government bodies (like the EU) and also by local authorities.
Grant funding is often the cheapest and preferred method of getting additional funds into a business. The biggest advantage of grants is that they are a cheap source of funding as the grant-giver does not expect a monetary return such as interest or dividends from the company that has been funded.
The grant-giver merely requires that the conditions of the grant are achieved and that the company provides reports showing the impact of the grants. In addition, the grant-giver may require an audit of the scheme or project or products that have been funded by the grant.
The major drawbacks for grants are two-fold:
- The grants may increase the administrative burden on the company as they often come with stringent reporting requirements.
- Grants are often difficult to get. Because the money is cheap, there is often lots of competition to get a grant allocation and the paperwork required for application can be onerous.
Debt funding is the most common source of business funding provided by banks, financial institutions as well as by private individuals.
The providers of debt funding generally charge interest. The debt providers will often require security for the money they are advancing to the business.
The security will often be in the form of a bond over the property being financed such as a mortgage bond over a piece of real estate or a general notarial bond of plant and equipment. Some providers of loans will also require the directors or owners of the business to provide personal surety over the loans.
The main advantages of loan financing to a business are two-fold:
- The interest that is charged on the loans is tax-deductible.
This type of financing therefore can provide the shareholders with higher after-tax earnings.
- The owners of the business do not have to give up some shareholding to 3rd parties.
The key disadvantage is that debt can choke and suffocate a business. Failure to pay the interest and capital repayment in accordance with the agreement could result in the business going into distress. The key assets of the business can be repossessed by the lenders and liquidated. The whole business can be taken over by creditors after a liquidation process.
Funding for business
Equity financing is when existing shareholders or new investors increase the principal capital of the business.
Existing shareholders can refinance the business by either subscribing for new shares or they could use retained earnings as additional sources of business finance.
The existing shareholders could also invite outsiders to inject capital into the business by buying shares. Inviting new shareholders has the advantage of bringing new people with possibly new and different perspectives. This could help the business grow in that the original owners can now tap into a wider talent pool when making strategic decisions.
The obvious disadvantage of the bringing new shareholders into the business is that the influence of the original shareholders is diluted. The advantage of bringing new shareholders is that the talent pool increases and the business will most probably grow faster.
As the business grows, it also faces bigger challenges because its sells more products/services, it gets more customers, its supplier base increases, its employees increase and the sophistication of management processes such as accounting, tax, legal and governance increases substantially.
Self-funding is when the business itself funds its growth through reinvestment of profits.
This is the most common type of funding especially for small- and medium-sized businesses. Start-ups which are often not bankable projects often rely on the funding provided by the entrepreneur and by the friends and family of the entrepreneur.
When a new business starts the entrepreneur and the business are often one and the same entity. There is no legal identity for the business. Self-funding of the business is often the only solution.
The entrepreneur will often secure loans in his own name for the benefit of the business.