Guide to business borrowing
CONTENTS
- Introduction – your guide to loans & debt funding
- Understanding financing options
- Loans and debt funding
- Making your business more fundable
- Here are our top ten tips to make your business fundable
- Overview of debt financing options
- Checklist: what debt funding options could be right for your business?
1. Introduction – your guide to loans & debt funding
You’ve just won a big contract and now need to increase your stock levels.
You are taking on another site and need to refurbish the premises.
You’ve grown your business over the last years and are now looking to expand into a new market.
Finding the right funding is often a key next step in turning new opportunities into profitable growth. Access to the right kind of funding at the right time plays an important role in growing a successful business.
There are many types of funding you might want to consider. In the How to fund your business guide we have given an overview of the broad options available to businesses at different stages of their development. Here we are now exploring the different types of debt funding options that can help growing businesses. We cut through the noise and give you the information you need to consider before starting to raise debt finance.
2. Understanding financing options
This guide is designed to help you navigate through the maze of loan and debt finance options, and to help you understand what it takes to access debt funding. Funding Xchange cuts through the noise and gives you the information you need to take control and identify your best funding option.
3. Loans and debt funding
Taking on debt means that you are retaining ownership of the company – but also means that you are not sharing the risk for growing your business with other investors. You will have to repay loans or other forms of debt according to an agreed schedule.
Many start-ups or very young companies struggle to get access to loans as lenders want to see a track record that ensures the business can pay back the loan or want to see that the company has assets that can be used as security. The Government has set up the Start-up Loans Company to provide access to low-cost loans of up to £25,000 for young companies. You can find out more at www.startuploans.co.uk
Loans typically carry interest on the amount borrowed. How much interest you pay depends on factors like how long you need the money for, whether the loan is “secured” against assets you own or future revenue streams, or other economic factors, like the Bank of England base rate.
As recently as 2010, high-street banks provided around 95% of business lending, businesses didn’t need to be aware of other forms of loan finance. Today, up to 20% of funding to small businesses is provided by non-bank funders – creating many more options for businesses.
More than 100 alternative funders are looking to fund small businesses in the UK. Alternative funders tend to be more flexible than other lenders. They are not regulated in the same way and do not have the same constraining capital requirements. These lenders have been finding new ways to assess business risk, reduce the operational cost of underwriting and insure risk. They are making it possible for many more businesses to be funded on attractive terms.
Product options range from familiar unsecured loans and overdraft-type products to innovative solutions like single invoice finance and merchant funding. In addition, P2P lending platforms, such as Funding Circle, Rate Setter and ThinCats, also offer loans to businesses. The difference is that the loan is typically funded by many individuals (“the crowd”) rather than traditional forms of funding (e.g. deposits and wholesale funding).
Funding Xchange helps you navigate these options and make the best of alternative funding innovation.
4. Making your business more fundable
So you’re a small business owner and have decided you need funding to help your business grow, take on more staff, buy equipment or to simply inject working capital. The good news is that small firms no longer only have the option of going to their bank! The huge expansion of the alternative lending market has brought with it a whole new world of options and alternatives. So the big question is how do you position your small business in the best possible way to access these different types of funding options?
It may come as a surprise but almost one in five British SME businesses (18%) have no idea what criteria will help them secure funding from a lender*. Perhaps SMEs have been conditioned by the traditional lending criteria of high street banks and are unaware of the other options that exist, such as peer-to-peer and invoice finance.
High street banks typically use assessment criteria that heavily feature filed business accounts as well as the business’ financial transactions that are visible through your business bank account. In principle banks will look for:
- Minimum of two sets of filed accounts (~3 years trading)
- Length of time you have been a customer with the bank (usually a minimum of 18 months)
- A good credit score for the company and directors
- Previous transactional history, such as number of days drawn on overdraft
- Historic profitability
- Demonstrable turnover (typically needs to be at least £100k)
Alternative lenders apply a more varied approach to credit assessment based on their own measures of creditworthiness. There are some fixed eligibility rules as well as specific underwriting criteria that are tailored to the funding product. To access funding from those lenders, businesses are expected to demonstrate:
- Six months trading history with turnover of more than £40k
- No outstanding CCJs / undischarged bankruptcies, and not be in an active debt management plan or CVA
Although it depends on the specific funding type, businesses could unlock a host of different finance options if they show some of the following features:
- Demonstrate affordability – meaning ability to repay the funding without putting a strain on the business. As a rule of thumb, funders typically view requests for funding that exceed 20-25% of annual revenues as potentially unaffordable. If you require more funding, expect lenders to look for additional security as well as proof that the business can repay the funding.
- Use business-to-business invoices to unlock funding – invoices issued to other businesses allow you to take an advance on revenues that you expect to receive in the future. For example, if you sell to Tesco but Tesco does not pay you for 100 days, you can get this particular invoice financed. The funding provider will look at Tesco’s strong credit rating to assess the credit risk.
- Use card payment receipts to unlock funding – if you accept card payments (either online or offline) this may allow you to get an advance on future sales.
So what does this all mean? Put simply, it means too many business owners are focusing on the wrong criteria when looking for funding: Nearly half of all business owners feel that a strong business plan is key to making their business attractive to a lender, whereas less than 15% felt that taking credit cards or issuing invoices would increase their chances of receiving funding*. In reality lenders want to see that small businesses can demonstrate serviceability, to meet repayments through cash flow and / or assets.
It also means that businesses that have been turned down by banks are still able to access the funding they need to grow their business.
*Data sourced from YouGov survey to a nationwide poll of 538 decision makers from SME businesses, who were asked what they thought made an SME business (i.e. size 1 to 249 employees) attractive when wanting to borrow money?
5. Here are our top ten tips to make your business fundable
- Dream big – but reality check how much funding you can apply for: The single biggest mistake businesses make is that they ask for too much funding and get turned down because they can’t afford it! Be realistic about how much you can apply for – typically 20-25% of your annual revenues is what finance providers feel comfortable with for unsecured lending. Also think about how much the monthly repayments will be and whether your business can afford the additional expense.
- Don’t wait until the last minute to look for funding – you have more options if you start early: The second biggest mistake is that business owners keep putting it off to line up funding until they actual need the money. The earlier you start looking for funding the more options you will have. You can use Funding Xchange as a simple tool to understand the offers available to you by completing a funding request in just six minutes.
- Be passionate about your business – but don’t forget to have solid financial reporting and forecasting: Finance providers may want to understand how aware you are of the commercial performance of your business and how you see your business growing in the future. They may ask you to provide financial projections, including projected cash-flow. It is important to put together well structured financial plans and be sensible when thinking about the future as it demonstrates how well you understand the economics of your business. You can ask KPMG SBA for help if you want assistance with the financial projections – and keeping information on the Xero cloud-accounting platform means that it is easy to pull information together.
- It is the boring stuff that matters – pay invoices on time and file your accounts: A good payment history is important when funders assess your business’ creditworthiness. It’s just like making sure you pay your household bills on time for personal finance.
- We know that business and personal life are inseparable for entrepreneurs – but keep business and personal finances separate: finance providers want to understand what income and expenditure is related to the business and what is personal to the owner. Having separate accounts also shows that you are serious about your business.
- Keep track of your business credit – just like you would do for your personal credit score. It’s vital that you understand what your credit score says about your business and that you know what factors are impacting your score. County Court Judgments (CCJs) and bankruptcy paints your business in an unfavourable light. A CCJ against your business will remain on your credit file for six years and could make it harder for you to access credit, so it’s imperative that you handle debts before they reach this point.
- Your personal finances matter – especially if you are looking for an unsecured loan: While funders want separation of business and personal finance, they will assess also your personal credit history – especially if your business is still relatively new or you are a sole trader. If you have a strong credit record you can even consider taking out a personal loan – this could be less expensive but makes you personally liable.
- Don’t assume that you need to have a perfect credit record – you may still be able to get funding: Running a business is tough and lenders can be surprisingly understanding when it comes to minor credit issues you have experienced in the past. So don’t despair if your personal credit score is not stellar or your business has faced issues in the past – there might be other options out there to funding your business from invoice finance to merchant cash advance.
- Get multiple quotes from different lenders – it pays big time to compare available options: Make sure you compare interest costs as well as any fees – especially for short-term funding the fees may be higher than the interest expenses. Ask funders to provide you with quotes that show you transparently the total costs of funding to make it easier to compare different quotes – or use Funding Xchange to get offers in a standardised, simple format. But having too many credit searches will harm your credit score (using Funding Xchange does not affect your credit rating).
- Think about whether you are willing to provide a personal guarantee: Many lenders will ask business owners/directors to provide a personal guarantee. This means that if the company is unable to repay, the owners/directors are liable to repay the debt. Funders often look at personal guarantees to see if the business owner believes in their business
6. Overview of debt financing options
What many business owners don’t know is that there has been a lot of innovation in new lending products.
These products give businesses access to working capital in many different ways, allowing you to find options that match your needs and provide the flexibility your business requires.
7. Checklist: what debt funding options could be right for your business?
7.1. Fast business cash
Fast Business Cash injects cash when you need it most. These are typically 3-10 month loans where cash can be in your account in days (or sooner).
Allows you to take advantage of short-term growth opportunities or cover unforeseen bills. Also used by seasonal businesses to smooth their cash-flow. Lenders assess your ability to repay the loan.
| key eligibility criteria | |
|---|---|
| Time Trading | 3+ months |
| Revenue | £40,000+/year |
| Credit record | No unsettled County Court Judgment (CCJ) |
| Profitability | Not required; credit provided based on expected availability of cash to repay loan |
| Credit card volume a factor? | No |
| Accounts receivable a factor? | No |
| Personal Guarantee | Typically required |
| typical terms | |
| Cost of credit |
Rates typically between 1-6% per month In some cases borrower only pays interest for the days credit is used (e.g., for 10 days) making this a great product for short-term borrowing Expensive / less suited to longer term needs |
| Repayment schedule | Automated monthly repayments; sometimes weekly or daily |
| other requirements | |
| Information required |
To receive a quote, you will share your most recent results (turnover, profit, total debt) To close the loan, lenders are likely to require bank statements for last three months |
Learn more about Fast Business Cash
7.2. Invoice finance
Invoice finance allows you to collect between 85-98% of the value of your outstanding sales invoices upfront.
Lenders usually take over commercial invoices (invoices you have issued to other businesses) making invoice finance suitable for companies that sell goods or services to other businesses. Lenders may or may not take over collecting money owed by your customers.
Particularly suited for businesses that are fast-growing as your access to financing grows with your turnover.
| key eligibility criteria | |
|---|---|
| Time Trading | 3+ months |
| Revenue | £100,000+/year (some new providers only require £40,000/year) |
| Credit record | Don’t need to have a perfect credit record, but your customers should have a good track record of paying suppliers |
| Profitability | Not required; funds advanced on individual customer invoices or your full sales ledger |
| Credit card volume a factor? | No |
| Accounts receivable a factor? | Yes |
| Personal Guarantee | Sometimes required |
| typical terms | |
| Cost of credit | Annualised costs of financing vary and can be 2-25% of financing volume |
| Repayment schedule | Depends – in some instances you simply accelerate receipt of an outstanding invoice (in this case, invoice finance is not debt and thus feasible to add to your existing funding mix even if you have existing lines of credit that restrict access to additional debt finance) |
| other requirements | |
| Information required |
For a quote, you will need to share details on the value of outstanding invoices or upload your sales ledger After you accept an offer, your customers may be contacted to validate invoices |
Learn more about Invoice Finance
7.3. Merchant funding
Merchant Funding gives you an advance on credit or debit card sales providing a flexible way of raising finance. You typically make repayments only when you receive card payments from your customers. Allows you to match repayments to your cash-flow.
Suitable for outlets, retailers, restaurants, online merchants or businesses with card terminals / visibility of future payment streams. You can typically borrow up to 100% of monthly sales. Can be used to top up other funding sources (e.g. invoice finance).
| key eligibility criteria | |
|---|---|
| Time Trading | 3+ months |
| Revenue | £3,000 – £4,000 per month |
| Credit record | Do not need a perfect credit record |
| Profitability | Not required; credit provided as an advance on predicted sales/credit card sales |
| Credit card volume a factor? | Yes. You will need to accept credit/debit cards |
| Accounts receivable a factor? | No |
| Personal Guarantee | Often required |
| typical terms | |
| Cost of credit |
Either an agreed fee or a percentage of sales. Typical annualised cost of funding is 30-80% of advance Given high costs of credit, less suitable for longer-term financing needs |
| Repayment schedule | Usually a small agreed percentage of daily or weekly card transactions until the loan is paid off |
| other requirements | |
| Information required |
For a quote, you will need to share your most recent results including monthly sales To close the funding, lenders may require three months of bank statements and recent card processing statements |
Learn more about Merchant Funding
7.4. Flexible line of credit
Gives you a flexible line of credit that can be drawn down as and when you need access to cash.
Funding can be flexibly repaid and re-drawn like a traditional bank overdraft.
| key eligibility criteria | |
|---|---|
| Time Trading | 3+ months |
| Revenue | £40,000+/year |
| Credit record |
Some lenders require businesses /directors to demonstrate good credit history and equity/net assets in the business. Some finance providers accept businesses with limited track-record, that are loss making or have recently restructured |
| Profitability | Sometimes required |
| Credit card volume a factor? | No |
| Accounts receivable a factor? | No |
| Personal Guarantee | Sometimes required; invoices/property can be substituted |
| typical terms | |
| Cost of credit |
Costs vary significantly based on your credit rating, volume of lending, and other factors; interest paid on capital drawn Expect annualised costs of about 10-50% |
| Repayment schedule | Funds can be flexibly repaid and re-drawn |
| other requirements | |
| Information required |
To receive a quote, you will provide recent results (turnover, profit, total debt) To close the loan, lenders may require a business plan, management reports / business bank statements. |
Learn more about Flexible line of Credit
7.5. Unsecured term loan
An unsecured term loan is arranged for a fixed period with monthly repayments, typically greater than 12 months.
Unsecured term loans are provided by a wide range of traditional and alternative lenders, including peer-to-peer platforms. Lenders will want to know what you are using the money for (e.g. hiring a new employee or entering a new market) and how this will benefit your business.
| key eligibility criteria | |
|---|---|
| Time Trading | 2+ months |
| Revenue | £40,000+/year |
| Credit record |
Businesses/directors need to demonstrate good credit history Less suitable for businesses with limited track-record, who are loss making or who have recently restructured |
| Profitability | Recent profitability required |
| Credit card volume a factor? | No |
| Accounts receivable a factor? | No |
| Personal Guarantee | Mostly required |
| typical terms | |
| Cost of credit |
Costs vary significantly based on your credit rating, volume of lending, and other factors Expect annualised costs of around 7-28% |
| Repayment schedule | Fixed period with agreed repayments |
| other requirements | |
| Information required |
For a quote, you will need to share your recent results (turnover, profit, total debt) To receive funding, you may need to share a business plan, management information / business bank and VAT statements |
Learn more about Unsecured Term Loan
7.6. Secured business loan
Allows a business to draw funds secured against assets (property, production facilities, machinery). A secured loan is arranged for a fixed period, e.g., the expected life-span of the asset used as security. The loan can also cover a shorter period (e.g. less than two years).
Lenders typically lend up to 80% of the value of the asset.
| key eligibility criteria | |
|---|---|
| Time Trading | Startup |
| Revenue | Not required |
| Credit record | Businesses/directors need to provide an acceptable asset as security |
| Profitability | Not required |
| Credit card volume a factor? | No |
| Accounts receivable a factor? | No |
| Personal Guarantee | Sometimes required |
| typical terms | |
| Cost of credit |
Costs vary significantly based on your credit rating, type of the asset, volume of lending and other factors Expect annualised costs of around 7-20% |
| Repayment schedule | Fixed period with agreed repayments |
| other requirements | |
| Information required |
To provide a quote, lenders will want to know details of the asset(s) you own/want to purchase as well as how funding will benefit your business Before providing funding, lenders may also require an appraisal/valuation of the asset(s) |
Learn more about Secured Business Loan
7.7. Start up loans
The Start Up Loans Company (SULCo) is a government funded scheme that provides a personal loan for business purposes and mentoring to start ups.
Support is available for individuals starting a new UK-based venture in the planning stages or which has been trading for up to 24 months. Only one loan can be granted per person, however more than one person in a company can be eligible. Every loan application is considered according to the needs of your business. While the final loan size is determined by your business plan, you could receive up to £25,000 and the average loan size is £5,500.
| key eligibility criteria | |
|---|---|
| Time Trading | Up to 24 months |
| Revenue | Not required |
| Credit record | No unsettled CCJ’s or bankruptcy, and not currently in a Debt Management Plan or Debt Arrangement Service |
| Profitability | Not required |
| Credit card volume a factor? | No |
| Accounts receivable a factor? | No |
| Personal Guarantee | Required |
| typical terms | |
| Cost of credit | The loan must be repaid in full with a 6% fixed annualised interest rate |
| Repayment schedule | To be agreed as part of your application process (must be repaid within 1-5 years) |
| other requirements | |
| Information required | You will need a business plan that is clear on start up costs the loan is funding and cash flow forecasts. SULCo can help with these |
| Additional eligibility criteria |
Anyone aged over 18 and living in the UK is eligible to apply You must have the legal right to remain in the UK for the duration of your loan term and the right to be self-employed |
7.8. Responsible finance
Access to finance, advice and support when commercial loans are not available.
Responsible Finance helps small businesses access community financial service providers, such as Community Development Finance Institutions (CDFIs), Credit Unions and Social Finance Funds
CDFIs are only able to provide loans to businesses when commercial funding is unavailable. CDFIs also offer businesses support, advice and mentoring.
There are currently around 60 CDFIs supporting customers in all regions of the UK; each CDFI is unique, serving local needs.
Find your local CDFI or read case studies at www.findingfinance.org.uk.