The self-employed have always been seen as a more risky proposition for lenders as their businesses are less likely to be established; they will also be influenced by external factors such as cost price inflation and regulation that affect costs or demand. The issue of small business credit is now at the forefront of the policy makers’ agenda as they have recognised the ability of these businesses to be the driving force behind a turnaround in the UK’s productivity issues. There are ways that you can give yourself the best chance of getting funding. Here, IPSE provides a guide to accessing business financing for the self-employed, and investigates the different routes currently available and the best ways to navigate them.
1. Do Your Research
The first thing to consider is what your business requires. There is a variety of lending products which will suit different requirements, from overdraft facilities which will suit short-term cash flow issues to long-term bank loans which cover start-up or scale-up costs. It is vital that you are clear on your needs and plans for the future so that you can seek the most appropriate finance.
Once you have decided what your requirements are, you should shop around before approaching any bank or institution for financing. Many independent workers report finding this particularly difficult as they tend not to be experts in financial matters and have to take time out of their regular working deadlines to do this research; however, the value of assigning time to properly researching the market cannot be overstated. The value in shopping around is because rates and terms for loans vary greatly. The headline rates that banks use to advertise their products may not tell the full story in terms of costs to the customer. The British Business Bank plays a role in channelling credit through its partners to a range of small businesses, particularly those that are looking to grow rapidly. But for a small business owner it directly serves as a great source of information for those who are seeking credit. With its finance guides and online tool, the website can help you research the market and decide what is best for you as well as put you in touch with mentors and experts who provide advice. Another good source of information is Business Banking Insight (BBI). Launched by the Treasury, BBI shows the performance of banks as reported by 20,000 SME owners.
2. Bank Financing
Once you have decided what you need and assessed the market, you will come across a variety of options from a number of different types of provider. The most prominent option is bank financing. Banks remain the largest providers of small business loans by an overwhelming majority. Banks offer a very broad range of products, from short-term solutions such as an overdraft to long-term loans and credit cards. Another benefit of obtaining credit from your bank is that it can easily be linked to other necessary banking facilities that your business uses which will allow the bank to regard you more holistically. The other benefit is that banks often have the greatest amount of consumer protection as a part of their offering. But the bank route is not without pitfalls and is usually the most frustrating for the self-employed as bank standards for accepting loan applications tend to be high.
Challenger banks, such as Metro Bank, Virgin Money and Aldermore, may help to lower the barriers to credit for small businesses by increasing the competition. One of the key takeaways from the credit crisis was that the market was too concentrated among a small number of banks. And while this is still the case with the ‘big four’ high street banks still holding 80% of all business loans in the UK, policy makers are making a concerted effort to open up the banking market to greater competition. Although the introduction of tighter regulation has been counterproductive to the aim of introducing more competitors there has been some success with new banks gaining a foothold in the market. While these challenger banks remain at the periphery and tend to have a more limited offering compared to their larger counterparts it is still worth finding out what they can offer. These challengers often look to carve out niche areas of the market rather than take on the larger banks head to head across the product spectrum. So it may be the case that their offerings trump that of any of the big four regarding certain clients or products.
What if you go to your bank and they say no? This, of course, is not the best experience as it often can be interpreted as a lender not believing in one’s business or the borrower’s ability. This often puts entrepreneurs off going down the same route or seeking credit altogether. But it is important to remember that being rejected is not the end of the story. Instances where an attempt to get business funding is rejected could be seen as a learning experience upon which you could capitalise to make changes to your business or approach that will ultimately make the proposition more attractive to lenders and clients.
There also other options to consider. In many cases banks are not an appropriate lender for a small business as the bank may struggle to generate a profitable margin from the loan and may not offer the right degree of flexibility. In these instances it may be best to look further afield.
3. Equity Financing
While banks offer most of the business financing in the UK, another option is to go through the equity markets. Equity is where the business owner offers a percentage of their business for funding thus assigning a value to the business as a whole. The more of the business that is sold as equity the more control the owner is allowing to be allocated elsewhere. According to British Business Bank analysis conducted this year, a total of £2.2 billion is invested in small businesses in the UK annually.
For those who are not familiar with equity financing, the Dragons’ Den show on the BBC is the best public example of microbusiness equity financing; in a similar way, partners that are brought on board take on a varying degree of input and responsibility in the businesses in which they invest.
4. P2P Lending
Peer-to-peer lending currently makes up a very small proportion of the overall financing for SMEs in the UK, but it saw rapid growth, of 75%, in 2015. Peer-to-peer lending takes on a variety of forms but the best known is crowd funding which is operated by companies such as Funding Circle, Crowd Cube and Crowd Funder. The key to crowd funding is being able to market one’s business successfully.
Communicating why your business has a strong USP which will generate demand can attract funding; however, being unable to get this message out clearly or widely enough will inevitably hinder a business owner’s chances of securing the necessary credit. Some key tips for crowd funding include building a wide and effective network, and personalising the pitch to achieve a wider appeal to help attract investors who may not be excited by the business idea itself.
5. Invoice Financing
Invoice financing or invoice discounting is yet another form of business financing. It is most frequently used to plug short-term cash flow issues along with issues arising from late payments or when the payment period covers an extended time. It allows a business to draw money against sales invoices before the client has made payment in order to tide over gaps in income. This can enable you to cover regular business costs, pay yourself or perhaps finance your next project. Banks such as RBS offer invoice financing as an option but it does adhere to fairly strict rules in order to minimise risk. RBS’ customers who seek invoice financing must, for example, turn over at least £250,000 a year, sell to other businesses and provide proof, such as time sheets or evidence of delivery of goods, in order to access this service.
Other providers, such as Market Invoice and Bibby, offer the same service with lower turnover requirements. But the same rules about how the business operates still apply, which, of course, excludes all businesses whose primary customers are consumers.
Lorence Nye is IPSE’s Economic Policy Adviser