How to finance a start-up? Let’s be honest, you’ve probably Googled this question a dozen times already. That might even be how you found this article in the first place. Start-up financing is a tricky business. And, securing funding that works for you and your new venture can be a real challenge. Every start-up is financed in a different way, from conception, to launch, to market. From grants and bank loans to credit cards, overdrafts and personal savings, there are so many options available. In fact, for many, financing a start-up comprises a cocktail of some or all of them.
So, we’re going to take a look at a few of the more common options that people in the UK use to finance a start-up. But, first, let’s take a look at some of the statistics…
1. Start-Ups, Small Businesses & SMEs: Some Statistics
Small and micro businesses, and SMEs, account for the vast majority (over 99%) of UK businesses. According to the Federation of Small Businesses, at the start of 2021, there were 5.5 million of them in the UK. That’s in spite of a (6.5%) decrease resulting from the pandemic. Together, SMEs account for over 60% of our private sector employment. And, most of those businesses have no employees at all. On average, up to 80 new companies are founded in this country every single hour! That’s remarkable. And, Brits are more likely to launch a start-up at the beginning of the year (from January to spring) than at any other time.
From the turn of the Millennium to the beginning of the pandemic in 2019, the average annual growth rate for UK start-ups was over 3%, with the highest business birth rate being in London. And, in the first two decades of this century, there were over 2.5 million start-ups registered in the UK. That’s an increase in the business population of over 70%!
With over 1,800 new businesses entering the marketplace every day, competition is fierce. Unfortunately, failure for some is inevitable. Half a million companies (not all start-ups we hasten to add) were dissolved between 2018 and 2019. And, it’s a startling fact that, on average, 20% of start-ups fail in their first year alone. Furthermore, two-thirds go bust within three years.
So, why do so many start-ups struggle?
Covid is impossible to ignore, of course. No business has emerged unaffected, whether that's positively or negatively. And, the financial fallout from the pandemic is unfortunately far from over. But, regardless of that rather seismic outlier, cash is still king. According to figures from CB Insights, close to 40% of start-ups fail as a result of cash flow problems. And that’s before we take the pandemic into account.
Getting your finances right is crucial. So, let’s take a look at what options are available for start-up entrepreneurs and answer some of the key questions surrounding start-up financing.
2. Should I use my own money to finance a start-up business?
From existing capital - like inheritance, personal savings, or redundancy money - to higher risk options like overdrafts (more on those below), re-mortgaging, loaning from a friend or family member, or the sale of assets, a lot of prospective business owners will use their own money to fund or part-fund their start-up business.
In fact, according to figures released back in 2019, almost one in four small business owners used personal funds to help finance their small business - either when starting up, or just to keep the business ticking over. That number has soared since the first lockdown in spring 2020. Since then, small business owners up and down the country have pumped personal savings into their business just to see them through the worst of it. But, unprecedented pandemics aside, exactly how much of your personal capital is it sensible to invest into a start-up? Here’s a few lines on this from Liam Winstanley. Liam is an Independent Financial Advisor and Director of Danbro Financial Planning.
“First, I’d like to clarify that it’s not for me, as a financial advisor, to suggest to anyone, client or otherwise, how much of their own money they should invest into their business,” Liam says. “In a sense, the whole point of entrepreneurism is risk versus reward. So, you’ve got to understand what the risks are going in and be comfortable with however much you’re putting at risk.”
“Let’s say you start a business. You’ve done your cash flow models and you work out that you’re going to need £50,000 to get yourself up and running and see you through the first two years. You’ve got to be willing to accept that, if after two years things aren’t going quite as planned, that £50,000 may well be gone. The big question before you start is whether you’re happy to accept that risk in order to pursue your dreams and ambitions. Is it worthwhile - particularly if the money you’re investing contains some or all of your life savings?”
“I suppose a lot of it comes down to a person’s own entrepreneurial spirit. How much do you believe in yourself and your new business?”
“When you start a business, particularly if you’ve been in a position of employment previously, the practical considerations are that you’re not going to be getting a regular wage anymore. So, you also need to consider, ‘how am I going to pay myself?’”
“As a financial advisor, I’d ask a client, ‘have you looked at your personal budgets?’ ‘Have you looked at what you’ll need each month to survive; i.e. mortgage, rent, bills, children’s costs, food shopping, etc.? Then, from a budgeting perspective, is there anything that you perhaps don’t need to spend as much on? So, in short, look at your outgoings and assess, ‘right, I’m currently spending x but if I cut this out and spend less on y then I reckon I can get it down to z.’”
“To my mind, the first milestone your business needs to reach is the point where it can pay you what you need on a regular basis. Some new business owners rely on their business to provide them with an income from day one. That’s not an ideal position to be in, particularly if you’re using personal capital to fund the venture from the outset.”
“So, if, via your start-up capital (however that’s sourced), you can be in a position whereby you don’t need to earn anything in, say, the first year or 18 months, it will take some of the pressure off. When that period then elapses, you should have a better idea about whether the business is going to work, how it needs to evolve, and where you are with it.”
“The question of how much of your own money it is ‘sensible’ to invest will always come down to choice and personal circumstances. But, regardless of your individual wealth or assets, you need to be absolutely clear about the risks and how much you’re willing to invest.”
3. Funding from friends & family
It’s certainly not unusual for budding entrepreneurs to approach friends, acquaintances and family members for funding, investment, and/or personal loans when embarking on a new business venture. The (often) flexible repayment terms and more ‘casual’ background checks, are the products of a good personal relationship and a willingness to help from the lending party.
Remember though, depending on the size and terms of the loan (if indeed there are any); the existence - or otherwise - of a contract; the success or failure of your start-up; and, ultimately, your ability to pay the money back; your relationship with the lender could be at risk.
Furthermore, if you accept funding from an associate in exchange for equity in your business, it’s important to consider your capacity - and prospects - for growth. Ceding a hefty chunk of equity to aid your cash flow might be useful - and necessary - in the shorter term, but it could come back to bite you further down the line.
4. What about a business bank overdraft?
Overdrafts are a common solution for businesses with short-term cash flow issues. They’re useful for giving an immediate shot in the arm to a start-up or small business that’s experiencing cash flow problems. That said, interest rates can be pretty extortionate and overdrafts don’t tend to be a viable long-term financial solution.
Most people have a personal overdraft or will, at least, know how they work. As for business bank overdrafts, we’re not going to go into the intricacies of how they work in this article, other than to outline that it’s a line of credit on your business bank account. They’re useful if you have short-term cash flow requirements that supersede the amount that’s available in your account.
Overdraft limits can be increased or reduced, pending approval from your bank. You can pay your overdraft back when your cash flow improves. However, depending on the arrangement you have with your bank, they can demand repayment at any time and may also demand a fee for the overdraft used. There are two key terms to remember when it comes to setting up an overdraft for your start-up:
- Arranged overdrafts. You and your bank agree on a set amount - a limit - that you can reach in your overdraft and will be charged accordingly as per your agreement. Unarranged overdrafts, on the other hand, are not agreed with the bank, and charges therefore tend to be higher.
- Secured overdrafts. With a secured overdraft, your overdraft gets secured against your business’s assets. For instance, if your business owns the premises from which it operates, the premises could be used as collateral in case you can’t repay your overdraft. These conditions do not apply to unsecured overdrafts.
5. What business grants are available for start-ups?
From schemes and specialist support to donations and awards, there are plenty of private and public grants available to new - and existing - businesses. Far too many to cover in this article alone. Fortunately, the Department for Business, Energy and Industrial Strategy have set out a comprehensive list of the various public funding options available to start-ups and SMEs, here.
As you’ll see, much of the support is sector or location-specific. Others may be awarded under strict limitations of what the money can go towards; i.e. research and development. While there are often strings attached - there’s no such thing as a free lunch - it’s worth a look to see what’s out there. You may also be eligible for certain private grants that do not appear on this list.
‘Matched funding’ essentially means that you need to source the same funding that you’re applying for from the grant. I.e. if you’re asking for a grant worth £8,000, you’ll need to ‘match’ that amount via an alternative route.
The Prince’s Trust have also helped tens of thousands of 18 to 30-year-olds get their new businesses off the ground via their Enterprise Programme. Free to enter, the programme offers entrepreneurs the opportunity to apply for low-interest personal loans (for business use) worth up to £25,000, as well as providing specialist skills, training, workshops and support to help you build your business. Individuals can receive one loan per business. However, multiple partners in the same business may apply simultaneously. The team will also help you schedule and structure your repayments. In some circumstances, small start-up business grants are also available via the Trust too.
There are also specific funding opportunities for business owners who’ve created, developed, designed or invented an original product or concept. UK businesses and research organisations, can compete for government-backed funding to support their research, development, testing and collaboration. Find out more here.
In that same vein, the government’s ‘Patent Box’ “encourages companies to keep and commercialise intellectual property in the UK” by applying a “lower rate of Corporation Tax (10%) to profits earned from its patented inventions”. You can benefit from the Patent Box if your business:
- is liable to Corporation Tax
- makes a profit from exploiting patented inventions
- owns or has exclusively licenced the patents
- has undertaken qualifying development on the patents
Of course, the amount of businesses accessing government grants has skyrocketed as a result of Covid-19 and the measures introduced to help businesses cope with the economic fallout of the pandemic. Business grants worth more than £11 billion were paid out to nearly 1 million businesses during the first 18 months of the pandemic. That’s on top of rates relief and £33bn+ in VAT deferrals. The situation surrounding what’s available is developing all the time. So, it’s always worth liaising with your accountant to see what funding is available to you and your business at any given time.
6. What business loans and other financing options are available for start-ups?
As above, the landscape surrounding business loans has changed dramatically since the turn of the decade. A House of Commons report published in December 2021 revealed that, in the first 18 months of the pandemic, £70bn was claimed by around 1.3 million businesses via the Coronavirus Job Retention Scheme alone. A further £28bn was also claimed across the five rounds of the Self-Employment Income Support Scheme. And, over £80bn worth of business loans were approved across a variety of schemes, with the vast, vast majority going to Micro, Small, Medium and Mid-Sized businesses.
The government’s ‘Future Fund’ also provides convertible loans to UK start-ups that ‘rely on equity investment and are pre-revenue or pre-profit’. Eligible loans must be matched by funding from private investors before getting converted into company shares. The scheme initially closed to new applicants in January 2021 (a new fund opened in July 21), with around half of all applications approved - totalling over £1.1bn.
But, away from Covid, what are the main types of business loans available to start-ups and small businesses?
Here are 12 of the more common types of business loan:
Secured & unsecured loans
Cash advance loans
Working capital loans
Community development schemes
Secured loans. Similar to the secured overdraft we discussed earlier, this is a fairly straightforward bank loan that’s secured against your business’s assets. As a result, these types of loans are more common amongst established businesses. Conversely, unsecured loans are not secured with any collateral. Instead, the business’s director/s (i.e. you) will have to act as a guarantor for the loan instead.
Start-up loans. This type of government-backed personal loan is specific to start-ups. Unsecured, they’re available to individuals looking to start or grow a new business. Recipients can also get 12 months of free mentoring too. Unlike other business loans, start-up loans don’t tend to require tax returns, balance sheets and/or profit and loss statements as eligibility requirements, making them easier to access for new businesses.
Short-term loans. Short-term loans cover a period of weeks or months and tend to have much higher interest rates as a result. They’re more suitable for businesses in need of a quick injection of cash, to cover a certain purchases or short-term cash flow issues.
Long-term loans. Longer term loans, as you’d expect, get paid back over a much longer period - sometimes decades. Repayments tend to be lower, which can help with cash flow management. Depending on the terms of your loan, i.e. whether it’s fixed rate rather than variable, your repayments and the terms of your loan will be unaffected by fluctuating interest rates.
Peer-to-peer loans. With a peer-to-peer business loan, a business borrows money from certain investors - often groups of individuals - as opposed to banks or more traditional lenders. The criteria for eligibility is often less stringent. Though, rates do tend to be higher as a consequence. The interest you pay on your loan also goes to the investors who funded it. And, as with many of the options outlined in this list, early repayment fees may apply too.
Cash advance loans. Cash advance loans allow you to borrow money against the future credit card sales of your business. They’re basically business loans that you pay back through a percentage of your card sales. You tend to get charged a fee when you get the loan initially, with flexible repayments thereafter. Loan approvals tend to be fairly swift with the amount you’re eligible to borrow based on turnover.
Working capital loans. A form of short-term loan, working capital loans tend to get taken out to support specific projects for which you don’t currently have the funds. For instance, if a building company has a larger than usual project to complete, they may purchase certain equipment or hire temporary staff to fulfil their obligations.
Invoice financing. With invoice financing, a lender acquires your outstanding invoices, releasing any money you’re owed by customers. The lender will then either collect the money direct from your clients (a process known as factoring), or you’ll recoup the money from customers yourself and return it to the lender in instalments (discounting). In effect, you’re selling your outstanding invoices to a third party for a percentage of how much the invoice is worth. Higher value invoice submissions tend to engender lower rates and vice versa. So, this is perhaps a better solution for larger, more established businesses, rather than new start-ups.
Equity finance. Equity finance, or the releasing of equity from your business, involves the sale of stocks and shares in your business to a bank or investor in exchange for capital. In simple terms, think of it as the Dragon’s Den approach. It’s a fairly straightforward way to bring money into your company, particularly early on, providing you can find a suitable ‘angel investor’ or ‘venture capitalist’ to buy into it. However, you need to remember that you’re relinquishing elements of authority and you’ll become answerable to shareholders who, depending on the terms of your exchange, may also want some input on aspects of how the business operates.
Asset refinance. In a similar vein, asset refinance can be an effective method of releasing the value of your business’s assets. With asset refinance, you’ll borrow money that’s secured against the value of a particular asset or piece of equipment. This could be a vehicle or machinery, for instance. The size of your loan is dependent on the lenders’ valuation of your asset and, as with any form of collateral, the asset may be repossessed if you fail to keep up with repayments. Generally speaking, asset refinancing is a more complex way of securing funds for your business, and it’s important that you’re on the ball when it comes to the intricacies of your contract.
Equipment leasing. Equipment leasing is where a lender buys or owns a particular asset or piece of equipment for which you then pay a fee to allow your business to use. This can either be a long-term, open-ended lease or for a set period of use. Using the example of a landscaping company, for instance, they might take on a project that requires the use of an excavator. But, if the company usually takes on smaller scale jobs and doesn’t own that particular piece of machinery, they may choose to lease it from another company for the period of that specific project. Another option would be hire purchase, whereby you make payments over a set period that lead to you owning a particular asset.
Community development schemes. Community development finance institutions (CDFIs) provide financial support to small and struggling businesses at manageable rates. Many are philanthropic, non-profit organisations with ties to local government. But, whilst they do great work and can provide invaluable support to community-based businesses, their lending criteria tends to be more exclusive and less lucrative when compared with high street lenders. However, CDFIs remain a decent option for businesses that’ve been overlooked by banks and traditional lenders. You can check your eligibility here.
We hope this overview helps. Of course, the landscape surrounding loans is changing all the time and other forms of business loans are available. For more on this topic, check out this free article from international finance experts, The Motley Fool.
7. Can crowdfunding help my business?
One alternative form of start-up financing is the concept of crowdfunding. Crowdfunding is the process of a collective group of individual investors contributing smaller amounts of money to generate one larger investment pot. Thanks to the rapid expansion of the internet, the popularity of crowdfunding has increased exponentially over the last couple of decades. Figures published by start-up funding network, Fundsquire, show that an average of £11,400 was raised per crowdfunding campaign in 2020.
If you’re looking to finance a start-up project, crowdfunding is a useful option, particularly if you’ve struggled to acquire the requisite funding via more traditional routes. Despite its viability, though, there are no guarantees. This is a ‘crowded’ market space. And you’ll likely be required to invest time, effort, and money into things like marketing and promotion in order to successfully attract suitable investors. ‘Speculate to accumulate’ you might say.
Furthermore, it’s also worth mentioning that raising large sums through crowdfunding is less likely, especially as a new start-up.
According to start-up experts, Startups.co.uk, ‘there are four different forms of crowdfunding’.
- Equity crowdfunding. This is the crowdfunding equivalent of equity finance, whereby you release some equity in your start-up business to ‘crowd funders’ in exchange for financial investment. With equity crowdfunding, it’s important to strike the right balance between the amount of money you want to raise and the level of control you’re willing to cede to investors. Not to mention the sensitive information you’ll have to release to the volume of shareholders you’re inviting into your business.
- Peer-to-peer crowdfunding. This option involves a business loan from a group of investors, sourced via crowdfunding. The loan is then paid back over time - with interest - by the business owner.
- Rewards-based crowdfunding. This is the less common concept of rewarding crowdfund investors with gifts, rather than financial repayments. The complexity arises from what that ‘gift’ is. Generally speaking, it tends to be free or discounted access to certain products or services provided by your start-up business. However, it could also be slightly more nuanced than that, such as naming rights or the sharing of intellectual capital.
- Donation crowdfunding. Difficult to attain and often only possible for specific types of start-up businesses, donation crowdfunding is exactly as it sounds. The business receives crowdfunded investment, perhaps because of the work they do or in order to assist with a particular project, without having to pay those investors back.
8. Are there any tax incentives for starting a business in the UK?
According to the Department for International Trade, the UK ranks as one of Europe’s ‘most business friendly’ economies, as well as having one of the lowest corporate tax rates amongst the G7 nations. Dividend tax exemption and the non-withholding of tax on dividends paid by UK businesses to parent companies overseas are two of the more appealing tax breaks for UK-based companies.
The country’s Capital Gains Tax rates, even after the pandemic, are also comparatively lower than other European nations. Furthermore, if certain conditions are met, companies can be exempt from Capital Gains Tax when disposing of company shares.
We also mentioned private venture capital investors earlier. Well, the government also offers several venture capital scheme options including the Venture Capital Trust; the Enterprise Investment Scheme; the Seed Enterprise Investment Scheme; as well as Social Investment Tax Relief. You can find out more about all of these schemes, here.
Elsewhere, tax relief and financial incentives are also available for eligible companies who invest in UK research and development projects. R&D tax relief is available to start-up businesses in a host of sectors. It works by reimbursing qualifying businesses for up to a third of their development costs via tax rebates, corporation tax reductions, or cash injections. The qualification criteria requires your business to be UK incorporated, liable for corporation tax, and meet HMRC’s definition of research and development.
One your start-up is launched, there are plenty of financing options available to get you through that crucial first couple of years. For instance, more and more start-ups and SMEs are using ‘business funding’ to help structure their business’s finances. 70% did so in 2019, before the pandemic began, with nearly half using outside finance.
What we hope we’ve made clear here is that, when it comes to funding a new business, there is no one-size fits all solution. Regardless of how you choose to finance a start-up though, you need to be sure you’ve done your research and taken care to avoid pitfalls both in the short-term and in the long run. Hence the importance of talking your plans through with a specialist business accountant.
Sam Wright is Danbro’s Marketing Manager. He produces regular content and feature articles on our digital and non-digital channels – and social platforms – for the Danbro Group and its subsidiaries, as well as having responsibility for the Company’s internal and external communications.
His background is in Journalism and Creative Writing, having previously contributed to publications such as The Daily Post, The Lancashire Evening Post, and The Blackpool Gazette.
He is a keen swimmer and avid Manchester United fan (but don’t hold that against him), and he lives in Lancashire with his wife, Sarah.