Finance for entrepreneurs and new business start ups

Finance for entrepreneurs and new business start ups

A few years ago I ran workshops about Finance for entrepreneurs and new business start-ups. This was great because I got to help people see whether setting up a business was for them. However, running workshops for a few people at a time means you are limited to the number of people you can help. I have therefore published the course on the internet. We’re going to have a look at:

  •  The types of finance your business can use, and pros & cons of each type
  •     How to increase cash in your business
  •     Business structures and your obligations
  •     VAT overview
  •     What to do when you take on employees
  •     Premises – rent versus buy
  •     Recommendations

When thinking about what type of finance you are going to use you should consider:

    •  How long is the finance required for?
    •     What are you funding? Generally, assets that last a short time should be funded by short term borrowing, whereas assets that last a long time can be funded by longer term borrowing.
    •     Can you afford the repayments?

As an entrepreneur, the main ways you can finance your start-up business are:

  • Mortgage on home
  • Bank loan
  • Loan from friends and family
  • Grants
  • Hire purchase
  • Leases
  • Outside investors
  • Keep a part time job while you set up
  • Sell personal assets you no longer use

According to research by Mintel, the main types of finance used by businesses are:

Bank & overdraft          50%
Personal savings            40%
Bank loan                      30%
Retained profit               35%
Friends                          16%
Family                           14%
Credit cards                   14%

Pros and cons of using personal savings to finance a new business:

Pro Con
Cheap, since your will not have to pay interest on borrowings since you have no borrowings If the business fails, you may lose the money you put in. However, for start-ups, using personal savings is likely to be the only way to fund the business since a lot of lenders will not lend to new business. If you do obtain loans from banks, they may require the owners to personally guarantee the loan in case the business fails. This means you would lose money, just the same as if you had put your own money in to start with.
Easier to obtain additional funding. If you have already funded the business it shows that you have confidence in it.
Maintain control. If you have no borrowings or other owners, you can decide how to run the business. As soon as you have borrowing and other owners you start to lose control.
No repayment deadlines. You will not have the worry of having to have enough cash to repay loans if you have used your own money.
If you have money in the bank it is unlikely to be earning you much interest, whereas if you borrow money there may be significant interest charges. You will therefore save money on interest by using your own money and not borrowing.

Pros and cons of using bank overdrafts to finance a new business:

When thinking about whether you should use a bank overdraft to finance a new business you should weigh up the following pros and cons:

Pro Con
Flexibility – Unlike a loan where you borrow a set amount of money regardless of how much you need at any one time, with an overdraft you borrow the money when you need it and repay it when you don’t. For example, if there are a few months a year where the business is seasonally slow, and you need loans to get through those months, but for the rest of the year you have spare cash, you may wish to use an overdraft in the bad months, because if you had a loan, you would have to keep the borrowing throughout the year, regardless of the fact that you have cash for most of the year. Overdrafts can work out to be expensive if used for long term borrowing. The interest rates are generally higher than longer term bank loans
You only pay interest when you are overdrawn, so if you aren’t overdrawn for a lot of the year, the interest may be relatively small compared to a loan. The bank can generally ask for repayment of the overdraft at any time, meaning if you have no other source of funding in place, the business could become insolvent and have to be wound up.

 

Pros and cons of using credit cards to finance a new business:

Many entrepreneurs have started a business using credit cards to pay for a lot of the costs in the early days. When thinking about whether you should use a credit cards to finance a new business you should weigh up the following pros and cons:

Pro Con
Credit cards often give interest free borrowing period. You could use a personal credit card to pay for some of the costs, and may not start being charged interest or have to repay the debt for many months or even a year to 18 months. Credit card interest rates are often very high if you do not pay off the balance in full each month, so should only be used in the short term where no interest is due to be paid, otherwise overdrafts and longer term loans generally become cheaper.
Pros and cons of using a mortgage on your home to finance a new business:

When thinking about whether you should use a mortgage on your home to finance a new business you should think carefully since you could lose your home, and should weigh up the following pros and cons:

Pro Con
Loans which are secured on assets such as your home generally offer the lowest rates of interest since if you can’t repay the loan the bank can sell the property, and hopefully not lose all the money they lent you. If you can’t repay your debt the bank may require the house to be sold to pay the debts, and you would lose your home.
If you do really well, and do not need the money you borrowed, you may be charged early repayment penalties by the bank if you wish to repay the money early.
Pros and cons of using a bank loan to finance a new business:

When thinking about whether you should use a bank loan to finance a new business you should weigh up the following pros and cons:

Pro Con
Generally cheaper than shorter term borrowing. Security is often required by the bank, such as a charge over your home or the assets of the business.
The payments you make are regular, and generally the same amount each month, meaning you can budget for them. Arrangement fees can be quite expensive.
You pay interest on the balance owing to the bank, regardless of whether you need the money. If you only need money in the short term, a long term loan may not be a good idea.

 

Pros and cons of using money from friends and family to finance a new business:

Many entrepreneurs have started a business using money lent from friends and family to pay for a lot of the costs in the early days. When thinking about whether you should borrow from friends and family to finance a new business you should weigh up the following pros and cons:

Pro Con
The money may be lent at a low interest rate, or even with no interest, meaning it is a cheap source of money. Additional outside influence and interest – If you own all of the business, and have no borrowing, to a certain extent, you can do what you want with the business. As soon as you involve other people they will believe they are entitled to have a say about where the business is going, and what decisions should be taken.
Friends and family may be more willing to lend to an unproven business than a bank would. If you can’t obtain lending from the banks you need to ask yourself whether the business is actually viable. You need to consider whether only friends and family would invest because they care for you, and whether there is a realistic prospect of actually making money.
Less onerous repayment deadlines – If you miss a bank repayment you could be in real trouble, and the bank could ask for the full amount of the loan to be repaid. However, if you can’t afford to make a repayment to a friend or family when you said you would, they may be willing to wait a little longer for repayment. If you do not repay the money when you say you will, arguments could arise, and you could lose friends, and may fall out with family.
Pros and cons of using grants to finance a new business:

When thinking about whether you should use grants to finance a new business you should weigh up the following pros and cons:

Pro Con
It can be thought of as ‘free money’ since you are being given money to do something you would have had to have paid for anyway. What requirements must you comply with? Some grants require you to create a certain number of jobs within a timeframe of a year for example. If you do not create the number of jobs you said you would, the grant money could be taken off you, and you may not have the money to repay, meaning the company would go bankrupt.
Applications can be time consuming to fill out and there is no guarantee you will receive the money. You could be better off focusing on making sales. Also, when you receive the grant you may have to monitor how the money is being used to the grant making body, which again can be time consuming.

 

Finance for entrepreneurs and new business start-ups – Summary


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