These are emerging, alternative sources of financing, where private lenders make loans to small businesses via an intermediary network.
These sources offer decent returns to investors so they are proving popular, but different platforms have different criteria so it’s worth having a look at all the options.
Lenders can provide practical input into running the business which can be useful.
This option can be cheaper than a bank loan but still needs to be taken as cautiously as you would a normal loan.
You’ll need to factor in the up-front cost – a fee is usually charged by the platform.
A useful source of finance if the business is growing rapidly and needs cash flow. It allows businesses to borrow money against the value of invoices due from customers.
There are two types – invoice factoring and invoice discounting.
You pass unpaid invoices to a third party in return for a proportion of the face value. They take responsibility for collecting the payments. When the invoice is settled, they will pay you the remaining amount less charges.
While factoring reduces administration, be aware that you are dependent on the credit-control competence of the factoring company to collect your debt – if they are not strong in this area, you could be borrowing more for longer and be liable for the associated interest rates.
In this form of invoice financing, you retain credit-control responsibility in ensuring invoices are paid. The third-party lends to you based on the value of these invoices. When the invoices are settled, the money goes to the lender and you also pay an amount of interest for the loan.
Invoice financing is flexible and suits businesses that have a flow of invoices – so you need to be generating revenue and getting paid by customers. It is a form of financing business that will grow as the business grows.
It is a form of unsecured borrowing, so your assets are not at risk, as they might be with a business loan. It can also be suitable for those needing business finance but which don’t qualify for traditional business loans. However, there is still a need to have a reasonable customer base to be accepted for invoice finance.
Admin costs can vary between providers, so be sure to check out a few options – or get a broker to do so for you.
This type of funding is typically provided by wealthy individuals or retired, successful business people. Angel investors will sometimes club together to form syndicates or angel investment networks.
An angel investor is often an experienced professional who can provide expertise and advice as well as financial support. For some businesses, this can make this source of finance invaluable.
A big difference to the other forms of finance covered so far is that you will need to give up some business equity in return for the financial investment. And, whilst there aren’t repayments to be made, the investor may choose to impose some restrictions on how the money is used.
A list of investors is available at the UK Business Angels Association.
This is a relatively recent way to source finance. Funding is accessed by pitching your business idea and offering some incentives to investors in return. It works based on asking a large number of people to invest a small amount of money. It can be a good way to raise funds for a new venture but will need a convincing proposition to get people to join in. The crowdfunding platform will normally charge a fee.
The downside is that there is no guarantee that the project will be funded. Crowdfunding is generally used by product or tech-based organisations and requires the ability to strongly market the business to generate enough interest. It can be very useful for start-ups and product launches.
There are several different types of crowdfunding:
- Debt crowdfunding – borrow from investors and payback with interest – similar to P2P lending
- Equity – sell equity in the business in exchange for investment
- Rewards-based – provide perks, incentives or rewards to people in exchange for providing financial support
A list of UK crowdfunding platforms can be found here: https://www.ukcfa.org.uk/about-us/members/
Businesses that tend to be of interest to venture capital funds are those with substantial growth potential. This is unlikely to be an option for most smaller businesses and venture capitalists will rarely invest in start-ups – but it is a possibility if the business is in an attractive niche or shows high earnings potential.
You will need to evidence a capability to scale up, and that there has been clear success to date.
There can be significant pressure on the business to deliver high returns to the venture capitalist.
Like angel finance, venture capitalists can also bring expertise to the business and help guide strategy.
Again, private equity investors are interested in companies with high potential for growth over the medium to long term.
Private equity investors are usually looking to improve the performance of a business via:
- Improvements in operations
- Entry into new markets
- Launch of new products
Investors will expect evidence of solid management. They will bring additional non-financial support in the form of strategic insights and guidance.
The typical lifecycle of private equity investment is five to seven years, after which investors would seek to sell their shares, having grown the value of the business.
With this form of investment, money is provided in return for shares in the business, so the investor has a stake in it. They will gain some strategic control which could, for example, be in the form of taking on the investor as a partner in the business. This, of course, reduces your control over your business.
Export and trade finance
For businesses that trade abroad, export finance helps mitigate risks such as delays in payment or defaulting customers.
If you are importing materials, suppliers will need to be paid in advance before shipping and so export finance can fill that gap between importing materials and the finished product.
Export finance can cover a range of funding options – more information can be found here: https://www.gov.uk/government/organisations/uk-export-finance
This is a form of private equity investment for companies looking to finance changes within the business. An advantage is that it involves no change of ownership or loss of control. Growth capital works well for more mature organisations that are profitable but not able to raise adequate cash to fund investments and expansion.
Funding comes from a combination of equity and debt sources – it is a form of debt but with the characteristics of equity.
It’s a suitable source of finance for businesses that may already have borrowings, but that want to fund a transformational change, such as new product developments, expansion into new markets, or make strategic acquisitions.
It’s an appropriate source of finance for high-growth businesses.
Growth capital funding can also be used to restructure the balance sheet to reduce interest-bearing debt, which then results in improvements in working capital.
A growth capital loan is secured with ownership/equity in the company if the loan is not paid back on time and in full.
Mezzanine funding or mezzanine loans do not fall into the category of either a pure debt or pure equity. It is a very high risk and high reward tool that fills the gap between senior debt and equity. A company uses this type of funding to raise money for specific purposes, rather than for more general financing.
A mezzanine fund pools the capital of the investors, after which it can be used for varying purposes such as recapitalisation, acquisition, or management buyout.
Mezzanine finance is usually treated as equity in the balance sheet. It is subordinate to senior debt but senior to common equity when it comes to the priority of payments.
Mezzanine funds differ from private equity in that the latter aims to take a stake in the company they invest in. Mezzanine investors, on the other hand, get regular interest payments. However, the loan may come with an option to convert into equity at a later date.
An incubator firm is an organisation engaged in the business of fostering an early-stage company through its different developmental phases until the fledgling company has sufficient resources to function on its own.
These are often funded by the public sector or academic institutions and can provide co-working space.
An incubator firm helps grow a start-up from an early-stage idea to a company that can stand on its own.
Services provided by incubators can include:
- office space
- administrative support
- strategic input
- education and mentorship
- access to investors and capital
- information and research insights and intelligence
Incubators either charge a fee for their services or take an equity stake in the start-up. The period of incubation can last from a few months to several years. The quality of the incubator is essential so be sure to check out their reputation and track record.
Here’s a directory although it’s a few years old now: https://www.gov.uk/government/publications/business-incubators-and-accelerators-the-national-picture
Enterprise agencies are not for profit organisations which aim to boost the local economy by providing business support and advice, along with alternative lending options.
They can provide alternative sources of finance for both start-ups and established businesses and often work together with the Enterprise Finance Guarantee scheme.
Enterprise agencies are organised regionally – to find your local organisation visit https://www.findingfinance.org.uk/
Government schemes & business grants
In the UK there are government support grants and subsidies available to help support entrepreneurs, providing a range of loans and grants to small and growing businesses.
They support start-ups and can help with an initial cash injection, although this is unlikely to be a substantial amount.
The funding isn’t always repayable, but it can be very competitive and difficult to secure and the criteria can be strict, e.g. targeting young people or specific sectors of the economy. However, you will keep ownership of your business.