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Raising capital

An early challenge when starting in business

What are the main options for raising money?

There are various sources of finance available for starting or growing your business. The first is that you provide all the necessary money from your personal resources, but this is not an option open to everyone.

If you are starting up, or are already in business and want to expand, then there are two main sources of finance: equity and loan finance. Venture capital firms and business angels can provide equity investments in exchange for shares in your company. They'll be looking for above-average returns and an exit route, usually within five years. They'll probably want some say in the way that you run your business, but can also prove to be an excellent source of expertise and contacts.

If equity is inappropriate, or you don't want external investors, then an alternative is loan finance. This allows you to keep total ownership and control of your business, but you'll probably have to provide personal guarantees. Lenders will look at the gearing (the ratio of loan finance to total finance) and won't lend if the gearing is too high. They'll also look at interest cover - the number of times that forecast profit exceeds interest - and won't lend if this figure is too low.

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Who lends money and why?

Most loan finance comes from the banks. They lend around 40 billion each year to small businesses, though other finance houses also provide loans. Sometimes loans come in the form of factoring (factors pay out against your invoices, though this is effectively just a loan secured on your sales book). Sometimes, they come in the form of asset finance, though this is effectively a loan secured on your capital assets.

The finance institutions take in deposits and then seek to make a return on this money. The level of interest charged depends on their perception of the risk of lending to your business. In general, small businesses are regarded as being a higher risk, so finance institutions charge a higher rate of interest and look for enough security to cover the loan in the event that you can't meet the repayments. Administration costs can be as high for small loans as they are for larger loans, so arrangement fees are also usually payable.

As with other costs, do what you can to reduce the interest charged. Don't be afraid to negotiate. As you build up a credit record the bank will be better able to assess the risk that you represent, and should be willing to reduce the interest charged, provided you keep up your repayments.

In addition to the commercial financial institutions, there are a large number of Community Development Finance Institutions. Many of these are managed by local enterprise agencies, but there are other non-bank loan funds as well. Whilst they'll also be looking for good propositions, and personal commitment, they are often willing to lend on softer terms - possibly a reduced rate of interest, less need for security, and so on. Ask your bank manager or a professional business adviser for a list of organisations.

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How much capital do I need to raise?

This depends entirely on your personal circumstances and the nature of your proposed venture. Prepare a detailed cash flow forecast as accurately as you can for the first year - this will give you a pretty good indication of your requirements. Allow yourself a level of contingency to avoid having to go back for additional finance.

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Can my business succeed without raising capital?

Every business needs adequate finance - to buy capital equipment and to provide working capital until sales start to produce income. You may find it difficult to get credit initially and may have to pay rent in advance, provide deposits for telephones, and so on. If you don't have sufficient personal assets, then you've little choice but to look for investors or lenders.

Even if you've got the necessary resources, you should approach your business planning as if you had to raise the money externally. This should convince you that your business venture is a risk worth taking.

Depending on your personal circumstances, you may be able to start on a small scale, perhaps part time, reinvesting the profit that you make and building up the business to the point at which you can work in it full time.

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Who can help raise the money that I need?

It makes sense to talk to your bank at an early stage about what they require from you to support a loan application. However, there is merit in preparing the best possible case so it may help to seek appropriate advice. They should be able to help you determine the ideal mix of equity, loan finance and grant aid, prepare a suitable business plan and complete any application forms that might be necessary.

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Hints and tips

  • The key to raising finance is a solid business plan, with rigorous market research to justify your sales forecasts, together with a demonstration of your determination and commitment.
  • Explain to prospective investors your total financial requirements, split into capital for fixed assets and working capital.
  • Don't expect investors to agree immediately. If they refuse to support you, ask for feedback, address the issues, revise your plan and go elsewhere. If financiers question the viability of your idea, perhaps you should too.

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