Sources of Finance

Bank Overdrafts
Purpose Temporary measure to cover short-term cash shortfalls arising from: General working "capital needs during the production cycle. Seasonal fluctuations. Minor acquisitions of fixed assets with short estimated lives. Advantages The system is simple and arrangements can be negotiated and set up very quickly. Amounts may be drawn or repaid within the agreed limits at any time without prior notice. Comparatively cheap. Interest is calculated on the actual balance owing on a daily basis. Once agreed the facility will generally be renewed each year if the company remains creditworthy. Bank does not require participation in the management of the business No loss of control in voting power. Disadvantages Legally repayable on demand though reasonable notice (at least one month) will usually be given. You will be told the period of the facility. Security in the form of a fixed or floating charge on business assets or unlimited personal guarantee may be required. The rate of interest charged rises with increases in the bank's base lending rate. Subject to renewal each year. Bank may want to see annual accounts, details of stock, debtors, creditors levels etc. Costs Interest is charged depending on the bank's assessment of the risk it is taking. The greater the risk, the higher the rate of interest (often expressed a % points above base rate). Calculated on daily balance, but debited on bank statement monthly, quarterly or half yearly.

Bank Loans

Purpose Refinancing of permanent/'hardcore' overdrafts. Financing the purchase of assets with estimated lives of between 5 to 10 years. Financing increased working capital requirements. Advantages Not repayable on demand but by a series of instalments over an agreed period. Repayments may be arranged to correspond to the estimated cash flow arising from the asset acquired or the projected cash flow of the business. Flexible repayment commencement dates. As both terms and amounts are fixed, helps cash flow forecasting. No loss of control in voting power. Disadvantages Security in the form of a fixed charge on business assets or unlimited personal guarantee is usually required. If defaults of capital or interest payments occur, the bank is usually entitled to demand full repayment of the whole loan. Business track record is usually required. Costs Interest is charged above bank base rate depending on the bank's assessment of the risk involved. Banks usually also charge an arrangement fee. A settlement penalty will be levied if the loan is repaid before the end of the term. Equity The equity capital of a business is the owners' interest in it, consisting of the share capital invested by them plus retained profits. Purpose Ensures that the company is properly capitalised. The debt: equity ratio should not exceed 1:1. Advantages Maintains the capital base upon which more debt financing can be raised. If investors prefer capital growth to regular dividend payments, this reduces cash outgoings. New investors may also have business skills to contribute in the management of the company. Not affected by rises in interest rates.

Disadvantages There may be some loss of control; ownership of over 50% of shares gives control over the business in most normal situations; ownership of over 75% of shares gives total control. It is often difficult to find a suitable equity investor. Costs Any annual dividends paid.

Factoring
Factoring is a continuing arrangement whereby the factor purchases the trade debts due to a business, as they arise. Usually cash payments of up to 80% of each new sales invoice are made, with the balance, less charges, being paid when the invoice is settled. Purpose Provides short-term finance to resolve cash flow problems arising from: Funds being tied up in trade debtors. The cash demands of rapid expansion. Advantages Provides a quick method of collecting debts. A large element of cash flow becomes predictable. The factor takes care of the maintenance of the trade debtors ledger and the collection of debts. No loss of control. Disadvantages The factor only takes over approved (good) debts. If value of total invoices taken over is high, the service charge could work out expensive. Costs Interest is charged at usually 20/0-3% above bank base rate or finance house base rate. In addition there is a service charge for handling the debtors records, debt collection, etc usually ranging between 0.75% and 2.0% of invoices purchased.

Private Loan
Purpose These may be used for whatever purpose required as long as the lender does not object.

Advantages Probable flexibility of terms. Disadvantages If family or friends are involved, could cause ill feeling in event of default. Costs Flexible -as agreed between parties.

Regional Finance Funds

These regionally based funds can provide seedcorn funding, equity and loan finance from 15,000 up to 2,000,000. Often supported by EU funds, leading to significant constraints. Purpose To provide expansion finance for the business, marketing or research and development costs. Advantages To provide expansion finance for the business, marketing or research and development costs. As equity finance. Disadvantages Investors want a high return on their investment. Need to generate sufficient cash in the long term to make the agreed payments of capital in the long term and interest and dividends in the short term. Specifically legally binding contracts and covenants. The imposition of a non-executive director on the board. Regular information and consultation on the performance of the business to the Venture Capital firm. Targets B2B and significant growth prospects. Agriculture, retailing and sole property development is normally excluded. Costs Need to show a viable business proposition. Time in agreeing the deal.

Enterprise Finance Guarantee Scheme

Purpose

If you are a small to medium-sized enterprise, you may have viable business plans that need funding and for which a loan would be appropriate. However, you may be struggling to access the finance or working capital required due to the economic downturn and because you have no - or not enough - security to secure a commercial loan. The Enterprise Finance Guarantee helps to overcome this by providing lenders, normally retail banks, with a government guarantee for 75 per cent of lenders' exposure on individual loans. The Guarantee is available to businesses throughout the UK through approved lenders.

Advantages The Enterprise Finance Guarantee supports lending to viable businesses with an annual turnover of up to 25 million seeking loans of 1,000 through to 1 million and is available to businesses in most business sectors. Established firms can obtain guarantees of 75% and are charged a premium of 2.0%. The maximum loan period is for 10 years.

Disadvantages Cost of finance and funding the higher interest charges and ultimate repayment. Costs Time and effort in obtaining the finance. Restrictive covenants.

Local Enterprise Fund

Purpose Local Business Enterprise Funds, if available, provide business loans to businesses that have been rejected by a high street bank. Advantages Provide assistance in putting together a credible business plan. If you are unable to gain funding from mainstream lenders you can apply to the fund for a loan of up to a maximum of 100,000.

Disadvantages As normal bank loan. Rate of interest likely to be higher that retail bank.

Costs Need to show a viable business proposition. Time in agreeing the deal.

Business Angels
Purpose High net worth individuals invest in unquoted companies and businesses that are willing to risk their capital in return for a return on their investment. Advantages Raising funds in the form of equity finance strengthens the balance sheet. Assistance from the business angel in the development of the business. It is surprisingly difficult to raise between 10,000 and 250,000 and business angels supply equity funds to fill this gap. Most investments are between 10,000 and 50,000. Disadvantages Interference from the business angel in your business. Business angels may be seeking a high return on their investment (20% - 30%). Loss of management freedom, dilution / loss of control, pressures to change the management team, lack of knowledge of external financiers. Costs The need to develop a personal relationship with the business angel and the costs associated with preparing and presenting the business proposition to the business angel network. Finding a compatible business angel.

Enterprise Investment Scheme

Permits individual investors to subscribe for new ordinary shares in unquoted trading companies and receive personal tax relief at a lower rate and on the gain made in the business, given the perceived increase in risk. Purpose As this is another form of equity funding its main purpose is to ensure that the company is properly capitalised. The debt: equity ratio should not be greater than 1:1. Advantages As for equity.

Amount raised may exceed value of shares because of the tax relief available to the investor. Business Angels use it.

Disadvantages As for equity. Equity together with his/her immediate family and business partners may not own more than 30% of the shares in the company. Scheme is only open to UK residents. Complex tax issues arise. See HMRC website Costs Professional fees for obtaining HMRC approval for personal tax relief, which the company may have to bear.

Grants
Purpose Grants try to promote public policy objectives. Examples of grants are those which pay for training, innovation and technology transfer and development, assist regional development, employment, redeployment, research or expansion or exporting. Advantages Grants are a useful subsidy and aid cash flow. Disadvantages Experts find it difficult to keep track of grants available. Not available in all areas and sectors. Usually only available for specified projects and business would be expected to contribute. Grants may impose restrictions. Costs Time spent finding appropriate grant, satisfying criteria and completing paperwork.