13 Sources of Business Finance For Companies & Sole Traders
It can be hard to find the right business finance when you need it. You might not know what the options are or where to begin.
Small businesses often turn to family and friends for loans, which can be risky and stressful. Bank loans are a common choice, but they can be difficult to get and come with high-interest rates.
Several different sources of finance are available, each with its benefits and drawbacks. Whatever your needs, there is sure to be a finance source that fits you perfectly.
In this article, we'll outline the different ways to raise money and the factors that affect your choice. So whether you're thinking about a short-term loan or long-term investment, you'll know where to start.
What is Business Finance?
Business financing is the money a business uses to fund its activities and grow. Businesses need to raise funds for a variety of reasons. For example, they might need money to:
- Cover day-to-day cash flow
- Expand the business by opening new locations or increasing inventory
- Invest in new technology or equipment
- Run marketing campaigns
- Hire new employees or train existing ones
So what are the best sources to get more money into your business? Well, that depends on several factors, which we'll discuss below. But first, let's look at the various types of funds available.
Classification of Sources of Funds
There are three main categories of funds:
Based on Period
- Short-term: Short-term funds are typically repaid within a year, for example, trade credits, business credit cards, and commercial papers.
- Medium-term: These are repaid over one to five years, for example, through bank loans, bonds, or public deposits.
- Long-term: When you need finance for more than five years, you’ll likely turn to long-term funds, for example, through venture capital or long-term borrowing from financial institutions.
Based on Ownership
- Owned Capital: This includes money that the business owner puts into the business, for example, through savings.
- Borrowed Capital: As the name suggests, this is money that the business borrows, for example, through bank loans, government grants, or venture capital.
Based on Generation
- Internal: These are the funds the business generates, for example, through profits or selling assets.
- External: These funds come from external sources outside the business, such as investors, creditors, and vendors.
Sources of Business Finance
Many different sources of finance are available, each with its advantages and disadvantages. The right choice for your business will depend on a variety of factors, including the size of your business, your financial needs, and business goals. Some of the most common sources include:
Family and Friends
One of the most common sources of borrowed funds is family and friends. Borrowing funds from family and friends can be a great option if you have a good relationship with them and are confident you will be able to repay the loan.
- This type of financing is usually easy to obtain and comes with low-interest rates.
- It can damage your relationships if you are unable to repay the loan. Because it is a personal relationship, you should only proceed if you are comfortable with the risks involved.
- Family and friends might not be willing to lend you the amount of money you need. So it's important to have another plan in case you can't raise the full amount.
Bank loans are another popular external source of funds.
- With bank loans, you retain full control of your company, and some banks will not have any say in how you use the funds.
- Bank loans usually come with lower interest rates than other types of lending, such as payday loans or credit cards. This makes bank loans a more affordable option in the long term, and you avoid having to use your own savings.
- Bank loans can be difficult to get, and the application process can be lengthy. This is because the bank will want to see a good credit history and proof that you can repay the loan.
- Some banks may apply restrictions on how you can use the funds.
- You might also have to provide collateral, such as your home or another valuable asset, which means you could risk losing your home if you can't repay the loan. So consider the risks carefully before taking out a bank loan.
Government-backed Schemes and Grants
There are several government-backed schemes and grants available for small businesses. The reason why grants are so popular is that they don’t need to be repaid.
- They can free up valuable cash flow.
- The application process is usually relatively straightforward.
- There is a lot of competition for these types of funds. So receiving a grant often gives your business more credibility.
- Government schemes and grants are often only available for specific businesses or activities such as start-up businesses or environmental projects. So it's important to ensure you meet the eligibility criteria before applying.
Credit unions are a good option for businesses that struggle to obtain sources of finance from traditional lenders.
- They have some of the lowest rates compared to other sources, and you can also tailor your repayment plan to fit your needs.
- Credit unions are usually more willing to lend to small businesses than commercial banks. This is because they are not-for-profit organizations primarily helping the local community.
- They usually have a much better understanding of your business than commercial banks because they are often run by volunteers who have experience running their own businesses.
- They can have a smaller lending limit than commercial banks. So if you need a large business loan, you might be unable to obtain the full amount from a credit union.
- They might not offer all the same services as commercial banks. For example, you might not be able to get a business credit card from a credit union.
If your relationship with your local credit union is good, they might be willing to provide you with a business loan even if you don't have perfect credit. So it's always worth enquiring about their lending criteria.
Crowdfunding is a relatively new type of funding. It involves raising money from many people, typically through online crowdfunding platforms.
- When you're short on cash, crowdfunding can give you the extra boost you need to raise funds and get your project going, especially if you have a good story to tell. It can be a great way to build a community of supporters and get early adopters on board.
- It can be a lot of work. You will need to create an engaging campaign, and you will need to promote it to your target audience.
- Crowdfunding is a high-risk option, and there is no guarantee that you will reach your funding goal. So if you rely on crowdfunding to finance your business, make sure you have a backup plan.
Business Angels are wealthy individuals who invest money in businesses for a stake in the company. If you have a good business plan and can convince an angel to invest, this can be a great funding source.
- Angels can provide you with more than just finance. They can also offer valuable mentorship and advice based on their experiences and your business needs.
- Angels are often more willing to take risks than commercial banks or venture capitalists. So if your business is in a high-risk sector, an angel investor might be more likely to invest in your company.
- Angels can be hard to find. You will need to do your research, and you might need to approach many people before you find an angel investor interested in your company.
Asset Finance & Leasing
Asset finance and leasing can be a good option for small businesses that need to purchase expensive equipment or machinery.
- It allows you to spread the asset's cost over many years and avoid needing a large upfront payment.
- It can be particularly useful if you need to purchase an asset that will grow in value over time, such as commercial property.
- Asset finance and leasing can also free up working capital because you can use the asset as security for the loan.
- You don't own the asset outright, so you will need to continue making payments even if your business is not doing well.
- You might need to pay higher interest rates than a traditional loan because the lender is taking on more risk by lending finance against an asset.
Overdrafts can be a good option for businesses that need access to extra cash or working capital on a short-term basis.
- They enable you to borrow money against your business bank account and can be used for various purposes like covering a late debt repayment.
- It is important to remember that business overdrafts can be expensive, and you must have a good relationship with your bank to be approved.
Business Credit Cards
Business credit cards are a type of short-term loan that can be useful for covering unexpected expenses or making purchases when you don't have the cash available.
- They can help you establish a credit score for your business, which can be useful if you need to take out a loan.
- Business Credit Cards can be easier to manage than other business financing types because you can track your expenses and make payments regularly.
- They can also help you control your cash flow because you can choose when to make payments and avoid interest charges by paying off your balance in full each month.
- They can damage your credit score if you don't make your payments on time.
- Business credit cards can be expensive because of annual fees, and the interest rate is often high.
Start-up loans are designed specifically for businesses in the early stages of development. They can be a great way to get the financing you need to get your company off the ground.
- You can keep control of your business because you will not need to give up a stake in your company in return for the investment.
- They can help protect your personal savings and wealth because you will not need to use your personal resources to finance your business.
- Start-up loans can also be a great way to build your business credit because they are a type of long-term loan. If you make repayments on time, it will help raise your credit score.
- Start-up loans can be difficult to obtain, and the interest charged is often high.
- Most lenders are hesitant about lending money to a new business as start-up businesses are considered high-risk investments.
- They can restrict your ability to bootstrap your new venture because it can be easy to rely on the loan, and you might find it difficult to innovate and grow your company without additional business financing.
- It is also possible that your personal credit score might be affected. Many financial institutions ask for a personal guarantee when you take out a loan because lending to small businesses can be risky. So, if you default on the loan, it could damage your credit score.
Venture capital is an investment that firms or individuals provide to businesses with high growth potential.
- The main reason venture funding is attractive is that it can help you to grow your business quickly because the investment allows you to scale up your operations and hire additional staff.
- You will receive guidance and expertise from your investors, which can be useful if you are not experienced in running a start-up.
- Venture capitalists can provide additional resources or fixed assets, such as office furniture and machinery, which can be helpful if you are starting and do not have the working capital to grow your business.
- Venture capitalists can also connect you to their network of contacts. This can be useful if you are looking for suppliers or customers.
- With venture funding, you will have less control over your company because venture capitalists will own a minority stake.
- The funding process can also be difficult and time-consuming. This is because you will need to pitch your business plans to potential investors and persuade them to invest in your company.
So, venture funding is not suitable for every start-up. You will need to have a strong business plan and be able to demonstrate high growth potential before you can attract investors.
Business incubators are programs that support businesses in the early stages of development.
- Business incubators are a great option because they can help reduce costs because you will have access to shared office space and resources, such as meeting rooms and printers.
- You might be able to access funding through the incubator program. This can be helpful if you do not have the resources to finance your business with your own funds.
- Incubators can provide you with a network of contacts. This can be useful if you are looking for suppliers or customers.
- It can be difficult to get into business incubators. This is because the application process is often competitive, and you might need to meet certain criteria to be accepted onto the program.
- Business incubators usually require a time commitment, meaning you might need to spend a certain number of hours per week working on your business at the incubator.
- They often have specific requirements that businesses need to meet. For example, some programs only accept businesses in certain industries or with a certain number of employees.
So, business incubators can be a great option for businesses in the early stages of development. However, you must ensure that you meet the program's requirements and are prepared to commit time to work on your business.
Factors Affecting the Choice of the Source of Funds
You will need to consider several factors when choosing the source of business finance. These include:
The amount of money you need to raise for your business
The amount you need will influence the funding source you choose. If you don't need much, try using your money or taking out a personal loan. If you need a lot of capital, you may need to look at options such as venture capital or bank loans.
The stage of your business
The stage of your business will also affect your choice of funding. If you are starting out, then you may be able to use a start-up business loan. If your business is already established, then you may be able to use venture capital or an equity investment.
Your business model
Your business model will also affect your choice of funding. If you have high growth potential, then you may be able to attract venture capital investors. However, if your business is more stable, you may consider other options, such as bank loans or asset finance.
Your personal circumstances
Your circumstances will also play a role in your choice of funding. For example, if you are a homeowner, you may be able to use your home equity as collateral for a loan.
Before you choose a source of funding, it is important to consider all of the options available and make sure you are comfortable with the risks involved before you decide which one is best for your business. With the right financing in place, your business can thrive and grow.