|T There are basically four main types of funding available to UK businesses each with different characteristics uses and costs.|
1) Grants – mainly provided by the government for specific projects/purposes, often needed to be matched by spending from the applicant. ‘The cheapest form of funding’ as usually it does not have to be paid back.
2) Debt – Low risk, low cost funding mainly available from banks. Debt is simply a loan which has to be repaid over a set term with an interest charge. Banks’ will normally want it secured against assets in a business. The different forms are described below:
- Overdraft – repayable on demand, but flexible.
- Term loan – debt with a specific repayment period, eg 5 years often secured against a specific asset. A mortgage is a good example of this. Often provided as a % of the value of the asset it is secured against.
- Factoring – Money is ‘borrowed’ against the debtor book of a customer. The factoring provider usually administers the debts and their collection. Provided as a % of the debts borrowed against. Flexible, like an overdraft. Especially of use to businesses with growing sales, however may cause difficulties for businesses that do not have growing sales or have large seasonal swings in sales. Usually used for very small businesses who have limited administration support.
- Invoice Discounting – Similar to factoring, however the business collects the debts from customers themselves.
3) Mezzanine – A specialised form of funding, primarily used in special situations such as larger management buy-outs. It is a half way house between debt and equity funding which has a higher cost than bank funding, but is cheaper than equity finance
4) Equity – High risk funding with a high return/cost. This is used where firms cannot secure the funding they need through the lower cost options (eg debt) because they cannot provide any/enough security for a bank or where the project itself is inherently high risk (eg a start up business). The higher cost of equity compensates the provider for the increased risk of losing all their money. Equity is usually in the form of shares which mean the provider owns a % of the business. Equity providers seek to take a ‘partnership’ approach to funding by offering to share the risk of the business with the owners.
Equity can come from a number of sources:
- Friends & family – usually small amounts
- Private Equity/ ‘Business Angels’ – wealthy individuals who often play a ‘hands-on’ role in company’s that they invest in. They typically provide up to £200,000 and up to £1m in syndicates
- Venture Capitalists – professional investors who realistically invest from £1 million to multi-millions.
An area that is rarely considered is the potential 'funding' that can come through Corporate Venturing, where one company invests in another, not necessarily funds but it often is through providing access to the resources and 'buying power of a larger business.