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Are you thinking of starting a new business or do you need funding for a fledgling business? You may be wondering what sort of funding is suitable. It can be tricky to get funding from traditional lenders if you are just starting a business and have no proven track record or financial statements.
In this guide we explain how to get funding for a new business. We also answer common questions like “what types of funding are available for new businesses?” and “should I use equity or debt finance for my new business?”
Table of Contents
- What is business funding?
- What are the pros & cons of using a short term business loan?
- How to apply for business funding
- Frequently asked questions?
What is business funding?
Many new businesses apply for business funding to help them grow. They need money to help them with startup costs including buying stock, marketing products, designing a website, hiring staff and paying for a business premises.
Business funding is a broad term including many different types of lending as well as equity finance. It includes lending from family members, individual investors, groups of individual investors and traditional lenders. It also includes equity finance which involves selling a share in the business in exchange for finance.
How does business funding work?
How business funding works depends on the type of funding and the lender’s terms and conditions.
Here is a summary of the main different types of funding for new businesses and how they work:
- Crowdfunding - this is often arranged through a crowdfunding platform. Individual members of the public can invest money in exchange for a small share in the business. Some businesses offer a service or gift in exchange for funding.
- Peer-to-peer lending - lenders are members of the public who lend money in exchange for interest and capital repayments.
- Angel investing - wealthy individuals invest in small businesses.
- Venture capital - this is often arranged through a venture capital trust (investment companies that buy shares in small businesses).
- Small business loan - traditional lenders like banks and brokers offer business loans to small businesses. Some lenders will only consider lending to businesses over a certain size and with a minimum trading period.
- Start up loan - this is a government-backed loan scheme designed for new businesses.
What is business funding for?
Business funding can be used for a variety of different purposes such as the following:
- Improving cash flow - new businesses often struggle with cash flow as they need to purchase equipment and stock before sales have started to come in.
- Purchasing equipment - many businesses need new equipment before they can start making sales.
- Buying stock - most businesses will need to purchase stock before they can start trading.
- Paying for marketing - you may need to pay for a marketing campaign, a new website or a social media campaign.
- Paying for staff - new businesses usually need to hire staff before they start making sales.
What's the cheapest type of business funding?
Different types of business funding have different short term and long term costs.
Equity finance is often cheaper than debt finance in the short term. That’s because you are selling part of your business in exchange for funding, rather than borrowing and paying interest. The investor will expect to access their investment once the business is sold in the future. If your business is successful then equity finance may end up being more expensive as you will need to part with a big chunk of cash if the business is sold.
Debt finance is usually more expensive in the short term. This is because you will owe interest and capital repayments on the debt, often straight away. Some lenders offer loans where you can roll up interest and pay it at the end of the loan period. Other agreements have flexible draw-down facilities where you can borrow and repay your debt within an agreed limit.
Should I use equity or debt finance for my new business?
New businesses may choose to use equity or debt finance depending on their situation. Here are the pros and cons of both approaches:
How do interest rates work for business funding?
Interest rates on business funding depend on the type of loan and the details of your agreement. Interest rates for shorter term loans and unsecured loans are often higher than those for longer term and secured loans.
Lenders often calculate interest monthly and may offer the ability to roll up interest and repay it at the end of the loan agreement. You should check your terms and conditions as you may pay interest on the cumulative balance (including rolled up interest) rather than the initial loan.
Most lenders tailor interest rates to the individual lender and won’t alway offer the advertised rate on business loans. It’s worth shopping around as interest rates can vary considerably.
How to apply for business funding
The application process for a business funding depends on the type of finance. If you’re applying for a simple business loan, then lenders will carry out business and personal credit checks. They will also ask for the following information:
- Personal details including photo ID
- Information about your business
- Bank statements and financial statements
- Information on how much you want to borrow and the loan period
- Details of how you plan to use the loan
Where to find funding for a new business
There are many places to find funding, depending on the type of finance you want to apply for. Here are some options for each type of funding:
|Type of loan
|Start up loan
|Small business loan
Frequently asked questions
It is sometimes hard to work out how much funding you need as a new business. Preparing a business plan and a cash flow projection should help to estimate your cash needs. You will need to keep an eye on your cash flow in case more funding is needed in the future.
New businesses may be able to apply for government grants and loans, depending on your circumstances. Start up loans are available for businesses that have been trading for less than 2 years.
Business funding costs vary depending on the type of loan and the terms of your agreement. You will have to pay interest on a business loan as well as arrangement fees and monthly fees. Some loans also have early repayment penalties.
Just like personal credit, business loans will affect your credit score if you default on a loan. However, using an angel investor or other equity finance won’t affect your credit rating.
Some lenders require a personal guarantee before lending to new businesses.
Some lenders will consider loan applications if you have bad credit. Lenders may require security and offer a loan with higher interest rates if you have a bad credit record.
Pre-seed funding is finance for very new businesses. This is the stage where you’re still trying to develop your product and launch your business. Many business owners fund this stage with their own savings or by borrowing from family and friends.
Seed funding is for new businesses that have a more developed business plan and strategy. Businesses at this stage may be able to get funding from angel investors.