7.04 – Opting for Debt
Exploring borrowing options is crucial when seeking external finance for your business. While banks are often the first choice, other sources such as family and friends, credit unions, and mezzanine finance should not be overlooked. This lesson guides you through these options and their implications.
Borrowing From Banks
Banks are the primary source of finance for nine out of ten new and small businesses. They offer various cash-flow and asset-backed financing products. However, banks might not always be the best fit for every need. In addition to major clearing banks, former building societies and smaller regional banks compete for small-firm lending. It’s wise to shop around for the best deals. Resources like Money Facts can help you compare options.
Case Study: Hippychick
Julie Minchin, a new mother, discovered the Hipseat, a product designed to ease the back strain of carrying a baby. She initially acted as the UK distributor for the German company that made the Hipseat. Later, she decided to manufacture the product herself. Julie funded her business, Hippychick, through a small family loan, an overdraft facility, and various grants. By 2021, Hippychick was marketing over 100 products with annual sales exceeding £3 million. This success story underscores the importance of leveraging multiple funding sources, including family loans and bank facilities.
Running an overdraft
An overdraft allows you to use the bank’s money when you lack enough of your own. It’s typically agreed upon annually but can be withdrawn at any time. Overdrafts are intended to cover short-term needs, such as the gap between paying for raw materials and receiving payment for finished goods. They are relatively easy to arrange and set up, but they come with the risk of being repayable on demand. This means the bank can change the terms as it sees fit. Therefore, overdrafts should be used cautiously, particularly for long-term financing needs.
Challenger Banks
Challenger banks are a new breed of financial institutions that offer an alternative to traditional banks. These banks, started by entrepreneurs, focus on speed and digital integration, making them suitable for SMEs. They provide quick account setups, often through smartphone apps, and their services integrate with platforms like Xero and QuickBooks. For a list of UK challenger banks, digital banks, and banking apps, visit Finder.
Term Loans
Term loans provide funds for a longer period, with interest rates that can be variable or fixed. They are suitable for financing long-term assets such as machinery, vehicles, and leasehold premises. Unlike overdrafts, term loans offer more stability as long as you meet the repayment and interest conditions.
Government Support
Government initiatives can also provide financial support. The British Business Bank, Start Up Loans, and Gov.uk Business Finance Support offer various schemes to help small businesses. These programs provide loans, grants, and advice tailored to different business stages and industries.
Factoring and Invoice Discounting
Factoring and invoice discounting are methods of funding sales after invoicing. Factors provide immediate finance, manage sales ledgers, and advise on credit risk. Invoice discounting operates similarly but allows you to retain control of your debtors. These methods can help smooth out cash flow, especially during growth spurts.
Leasing and Hire Purchase
Leasing and hire purchase are options for financing assets such as vehicles and office equipment. Leasing can reduce the risk of obsolescence and cover maintenance costs, while hire purchase allows you to eventually own the asset. These options can free up funds for other expenses.
Credit Unions
Credit unions offer a cooperative alternative to traditional banks. They are particularly attractive to low-income individuals and self-employed groups. The Association of British Credit Unions provides information and a directory of credit unions in your region.
Borrowing from Family and Friends
Family and friends can be a valuable source of finance, especially if you face credit challenges. However, this approach has risks, including the potential to strain personal relationships. It’s essential to agree on proper terms, put the agreement in writing, and clearly explain the business risks to your loved ones.
When considering borrowing from family and friends, ensure they can afford the investment and understand the potential downsides. Avoid borrowing from individuals on fixed incomes or those who cannot afford to lose their investment.
