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Corporate finance - Sources of funding for small businesses

By Edited Aug 3, 2016 0 0

 All unincorporated businesses require working capital in order to pay for the day to day running of the business. Some unincorporated businesses are self funding, i.e. the income they generate pays for the running of the business however most are not and will require some kind of finance to trade. Many people would think the secured business loan is the only form of finance available, however there are many sources of finance an unincorporated business can look to in order to get the cash required to get them up and running and to the stage where they can be self funding.

Bank overdraft

If the business requires a small amount of money for working capital a bank overdraft is often the best solution and this is often the most common. An overdraft is effectively a pot of cash the business can dip in to as and when it is needed. Unlike a loan, an overdraft is not a physical amount of cash that is given to the business on day one. Instead, an overdraft allows the business to go overdrawn, i.e. take more cash out of the bank account than is actually in there, up to an agreed limit. The business will be charged interest for this privilege, which is calculated on the amount ‘borrowed’ multiplied by the agreed interest rate.

A bank overdraft is unsecured, i.e. the bank will not require any fixed or floating charges over the business assets nor will it require any personal guarantees from the business owners. This is advantageous as it does not tie up assets that may be required for future funding requirements.

The biggest disadvantage with an overdraft is that the bank can call it in at any time. In reality, the bank will seldom do this unless the business frequently exceeds the overdraft limit.

  •  Bank loan

Bank loans are often taken out when a business first starts to trade. During the first few months it is likely there will be a lot of expenditure (buying equipment and plant, setting up the offices, buying stock etc.) and little income generated from sales. To fund the business through the initial period a loan is often the preferred source of finance.

A business loan is much like a personal loan in that the bank gives the business a load of cash to spend it as they wish. The loan will then be repaid over an agreed period of time at an agreed interest rate. The loan agreement between the bank and the business will be written so that the loan will not become instantly repayable unless the business defaults on the obligations, the most common of which is when repayments are late.

Once the business is established a bank loan will only be taken out to buy expensive new assets or to consolidate all existing borrowings. A bank loan is not suitable to fund working capital purposes.

  • Invoice discounting

Invoices discounting is effectively selling the business’ debtor book at a discount. A business may give the customers 30 day credit terms, therefore when a sale is made the customer has to pay for it within 30 days. During the 30 day period the business is effectively funding the customer. One way around this is to ‘sell the debts’ to an invoice discounting company.

Once the sale is made the debt is recorded and then sold on. The business gets the cash immediately but the debt is not sold at full value, and this represents the finance cost of this arrangement. The exact rate will differ from invoice discounting provider to invoice discounting provider although it may be as much as 20%. This means if the business makes a sale of £100 it will only receive £80 from the invoice discounting provider, hence it can be an expensive form of finance.

  • Cash injection from the proprietor or partners

By virtue of a whole range of circumstances, such as inheritance, the sale of a property, a gift from a rich relative, the sale of some personal assets etc., the business owner or owners may come in to some money, which is subsequently invested in to the business.

  • Cash injection from family or friends

The business owner may know of some individual, such as a family member or a friend, who has some disposable income and is willing to invest in the business. The family member or friend is likely to want some kind of return for their investment, and since they cannot buy shares in the business and receive a dividend, this return is going to have to be through an interest charge.

When a financial arrangement like the above is set up it is advisable to get a solicitor to draw up an enforceable legal agreement so that every party knows the precise terms and how the repayment of the loan is going to work.


As detailed above there are many of potential sources of funding for unincorporated businesses, therefore it is worth looking at all the options and carefully considering each one before deciding what is best for your business.



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