Bank Loans - nine out of ten small business firms use banks to raise business finance. Banks are looking for the security of a company asset, so they have relative certainty that they will receive their money back at the end of the period. Banks will charge interest rate that reflects the conditions of the current market and also the level of risk attached to the proposal. Banks also look at the range of factors related to the borrower themselves, when evaluating loan requests. These include the character of individual (in terms of their credit history and whether or not they have a history with the bank itself). Banks also look at the capacity in other words the borrower's ability to repay a small business bank loan, based on a credible business plan. They also look of the collateral of a borrower to see if the asset proposed is worth in excess of the loan. Banks also look at the capital to see whether or not the assets exceed the debts.
Overdraft - the main type of short-term bank funding is overdraft which is usually secured based on the assets of the company. An overdraft facility is commonly used when companies have volatile cash flows in and out of business. For instance, the need to purchase raw materials for production. Other types of bank lending banks are also a good starting point of the debt financing because they can provide less of credit for businesses who require them to facilitate dealings with overseas suppliers. Some suppliers may need paying settlements in their own currency which can easily arranged with a bank.
Term Loans - if a business needs to invest in some new machinery for some kind of large long-term manufacturing process such as printing or manufacturing, it normally expects profits to be returned over a number of years. Raising business finance required for these large capital investments also needs to be financed over a long period time. Term loans provide a long-term commitment for company. The interest on time loans can either be fixed or variable. Fixed rate loans at present about 50% of loans across the UK. The main advantage with term loans is that banks cannot pull rug out from under the owners of businesses feet back its unlike overdrafts. About one third of term loans in the UK are over 10 years and about 25% less than three years. Terms loans are marketed by financial institutions using the following commonly used product groups:-
- Business Loans - Commercial business loans are designed to support the start-up firms and all are subject to the credit status of the business and its owner. They are very similar to the structure of personal term loans in that they have pre-agreed length of time, fixed or variable interest rates as well as potential exit and early repayment penalty clauses. The main difference is that high street banks will usually offer these types of loans via a small business adviser whose job it is to oversee the book of business in that local branch area. Cross selling and up selling of other products will be one of the advisers primary measures of success and many small businesses will tend to obtain their loan from the bank that already provides their bank account. The credit crunch has made it more difficult to shop around and compare business loan from lenders. The number of loans on the market and stricter lending criteria is forcing more and more small businesses to opt for a loan from their own branch.
- Commercial Property Mortgages - The credit crunch has made obtaining commercial lending very difficult indeed, as commercial property prices in the UK have plummeted. Refinancing also includes the remortgaging of commercial property. In the past, many business owners have been into this option, during a record period of property price growth and easily obtained mortgage credit. However, the prospect of negative equity (where a building or asset has reduced in value to that of less than the loan secured against it), is now a very real issue in the current business climate.
- Secured Loans -a secured loan is usually secured over an asset of a company such as buildings or land. Providers of capital who of secured loans want to ensure their order of repayment is high. Charges secured over assets are usually defined as fixed charges or floating charges. Fixed charges are highly specific such as land, property and buildings. Floating charges are attached to "shifting fund assets” such as stock. If a company defaults on its loan repayments, it may cause the floating charge to “crystallise" and become a fixed charge.
- Unsecured Loans -During the last decade interest rates and inflation remained relatively low and consumers have enjoyed relative cheap finance. A huge range of unsecured personal loans have been marketed and sold to millions of people across the UK. The interest rate of an unsecured loan depends largely upon the individual's credit score rating. An impaired credit history (linked to unpaid bills, county court judgements, and all other socio-economic data), may dictate and individuals ability to achieve a cheaper unsecured loan. Individuals that continue to apply for a variety of quotes from loan companies will have a larger credit file and a 'footprint' which other lenders can see. It may appear to lenders that the potential borrower is shopping around the best deal, if there is lots of history footprint on the file. Unsecured loans have similar characteristics; Firstly, they are typically short-term and are expected to be repaid within a few years. Secondly, they are charged on a monthly basis which means that the borrower can budget for sensible repayments. Thirdly, there's no need to put up any security for the loan i.e. it is unsecured. The marketing of these loans has become lifestyle specific. Advertisements target interest groups such as the young couple needing a conservatory or home extension, or the wedding reception. The most popular form of unsecured loan for buying a car, which accounts for about half of the loans issued in the UK. Now the credit crunch is biting, lending criteria has tightened and repayment of old unsecured loans is becoming a higher proportion of ordinary families disposable income.
Credit Unions - credit unions are a useful alternative to mainstream banks and are formed by groups as individuals or businesspeople. They provide a cheaper and more convenient method of banking. The members of the union have to save a regular basis in order to qualify for a loan from the credit union. There is no interest rate which is set. A dividend is normally payable to all members of the union, generated from any surpluses and is approximately 5% per year. This represents a good return compared to high street business interest rates.
Local Exchange Trading System (LETS) - since the mid 1990's, there have been hundreds of UK based local exchange trading system's (LETS) in operation. This business model provides a form of old fashioned bartering, where skilled members provide small business services to other members (such as gardening, plastering, plumbing and so on). The price of a job is based on a notional currency has been adopted by the members of the system. Although no actual money changes hands, the provider of the service receives a 'credit onto his account'. This person in credit can then use this to buy other services from other members of the system. In effect it's a simple way for skilled tradesmen to receive services they would otherwise would have had to pay for. One of the critical areas of success to ensure the system works is a local and innovative community organiser, who can maintain a comprehensive directory of local members and their specialist services.
Asset Backed Leasing - businesses that use physical assets such as cars, excrement and computers can lease equipment, as opposed to purchasing the same equipment outright. This is usually done using some kind of hire purchase agreement or 'finance lease'. This finance vehicle has the business benefit of reducing the cash out flow for a new business or a business seeking to grow. This means they do not to obtain capital loans and term finance. Operating leases are usually taken out on the basis that the company will use the assets for less than the expected life of the economic asset. The lessor takes a calculated gamble that the asset will not become obsolete before the lease term ends, providing a residual value. They take into consideration the responsibility / cost of insuring and maintaining the equipment should go wrong. The business user simply pays a regular hire charge for the equipment/ asset. Hire purchase agreements are similar in principle, apart from the fact that the business will own the assets at the end of the agreed term after completing all of the agreed payments over the period. Alternatively, a company could adopt an 'operating lease' model; which is more expensive than a finance lease. This is because the lessee pays regular amounts equivalent to the economic life of the asset (minus profit margin) and bears the cost of maintenance and insurance themselves. Most leases have some kind of extension clause built into the lease to assist the leasing organisation to resell an additional lease at the end of the term.
Trade Credit - once a small business has established itself with its suppliers, the suppliers may provide some form of trade credit to the business. This usually means that the business has between one week and three months before they have to pay for the goods or material or services, they've purchased from the supplier. This has the obvious advantage of providing critical breathing space and cash inflow, which the business can exploit elsewhere. Most trade credit provides incentives and 'discounts for cash settlement in full'. It is only natural that the supplier does not want to extend credit facilities any more than they have to, to secure future business. For a small business, pay now for a discount or pay later at a slightly higher amount is a simple numbers game. Does it cost more to save money from a discount for cash than the time value of money for the trade credit offered? This time period could mean paying employees wages on time or purchase additional materials to sell on etc. Trade credit facilities are usually only offered after an established period of time. Suppliers providing trade credit will normally require permission to undertake a credit check on the company creditworthiness. With the introduction of the Late Payment of Commercial Debts Interest Act, small businesses are allowed to charge interest on late business debts. From recent studies however, these legislative changes have had little impact on small business late payments and outstanding business debts.
Business Angels - in exchange for some equity in a small business, a business angel may provide both the capital required to get the business going all revitalise business, as well as possible expertise in a particular industry. These business angels are basically private individuals and investors who may provide the critical advice and capital required for struggling businesses to survive. Business angels are typically very wealthy, experienced, private individuals with a keen flair for business and an entrepreneurial outlook on business. A business angel might also be part of a larger syndicate seeking specialist investments in high growth industry sectors. Some syndicates or angels will require control of the company and others may take more laid-back and hands-off approach. It is important to challenge the skills and experience a business angel claims to bring to the table. If the Angel insists on day-to-day control and close working relationship then any personality clashes could prove disastrous. Their primary motivation is to see a return on the investment. Most business angels are seeking extremely high return from businesses that can scale with funding further funding restrictions (such as software). The business angel will normally be as interested in the personality and attitude of the business owners as they will the business itself. There are thousands of business angels across the UK and it is estimated that every year they invest hundreds of millions of pounds.
Grants and Awards - all struggling businesses may be able to receive financial help from their local district council or from central government. Unlike loans and other forms of borrowing, business grants are usually refunded. It's a great way to raise badly needed cash. A useful starting point is the local council and business Link office which will give details of grants available in the local area. It is a good idea to meet the person in charge of the grant decision personally, rather than just make the telephone call. When discussing the application for the grant the criteria for its suitability can be established and any changes made if required. It is also sensible to produce a comprehensive business plan to demonstrate to the grant officer that yours is an application which should deserve funding. It is also important to establish any timeframes for the award of the family grant because grants are usually based on annual all the regular timeframes.
Venture Capital - venture capital providers also take an equity stake in the business in exchange for investment of capital. These businesses are largely targeting huge funds and invest millions of pounds at a time. Typically a venture capital organisation will raise money from other providers in order to provide a complete package for a business. Similar to all types of lenders, Venture capitalists will go through a due diligence process to establish the full facts provided by a start-up business or existing business, are accurate and correct. Venture capitalists are motivated purely by investment return and will exit the business usually within five years.
Going Public by 'Floating the Company' - another option to raise money is to offer shares on the stock exchange to the general public. That option is typically for much large companies due to varying rules of stock markets in London and elsewhere. These rules include the proportion of a company's shares that must be allocated towards a flotation, its existing capital size, as well as the number of initial shareholders. The most popular market for small businesses is the Alternative Investment Market or (AIM) which is a smaller specialised stock market and has got around 2000 companies within it. Raising business finance via stock markets means exposing the company's financial figures to public scrutiny on a regular basis. Its share price will go up or down depending on the expectation of the market with regards to the company's future performance. Any negative or bad news in the press can have a negative impact on the amount of cash invested into that business in the future.
Debentures - the indebtedness of a company to a creditor is acknowledged by way of a debenture. An example of a debenture is a mortgage or freehold land owned by a company, it being a security of the company and a charge on its assets. Debentures are either irredeemable or redeemable. Redeemable debentures are expressed as payable on demand or on a fixed date in the future. Should a company redeem the debenture they can then be reissued by the company unless otherwise stated in the company's articles. Debenture stock is money which has been borrowed from more than one lender on the same lending terms. These lenders become a class of creditors - their rights are set out within their trust of deed. The trust has a committee which acts to represent the financial interests of the lenders. The deed of trust document will have the obligations of the company owes to the trustees. This will include the amount of loan outstanding and the interest rate and specifically it will determine whether the loan is of a fixed or floating charge nature. This is a highly relevant in cases where a company has defaulted in its repayments to the debenture holders.