Starting a successful business generally requires a tremendous amount of dedication, perspiration and inspiration.
But even with those key three ingredients in place many new businesses will struggle during the early years without sufficient access to funding.
Taking out a loan is a tried and tested method for accessing cash now that will be earned by the business in the future, but how does a startup company go about obtaining a business loan?
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Who Provides Startup Loans?
Many of the funding sources available to established businesses are out of bounds for startups. Lenders like to know that their investment is safe and, without a few years of sales history to present as evidence, startup companies may not meet the stringent lending criteria for the best deals of many banks, peer to peer lenders or alternative lenders.
The following sources provide loans for startup companies.
Since the financial crisis, bank lending has been harder to come by.
Lending to businesses in particular has taken a hit since it's seen as a riskier investment for banks than lending which is secured against a readily saleable asset e.g. property. It's therefore common for a bank to require a personal guarantee from the owners or directors of a startup company before they'll agree to lend it money.
A personal guarantee effectively transfers liability for repaying the loan from the company to the individual should the company go bust.
Before you get to that stage the bank may need to have been wowed with an impressive business plan that forecasts sufficient cashflow over the life of the loan to make the repayments.
Companies that are already established may need to show evidence of sales figures and prudential financial management, including bank statements if the business account is with another bank.
Start-up Loans is an initiative of the UK government which provides loans to startup companies via the publicly owned British Business Bank. Low cost loans of up to £25,000 are available to entrepreneurs aged 18 or over who live in the UK and whose companies are less than two years old.
Recipients of Start-up Loans can also receive mentoring and access to a range of other products to support development of their business. The loans are usually unsecured which can help entrepreneurs start companies without taking on large personal risks.
Friends and Family
We observed that a large proportion of the start-up cash for many businesses comes in the form of loans from friends and family.
While this route cuts out the need to make applications to banks, it should still be treated with the same seriousness.
We believe some common errors when borrowing from friends and family include not drawing up a loan agreement which specifies the loan amount, the term over which the loan is to be repaid, a repayment schedule, whether the loan is secured or unsecured and what happens in the event that the loan is repaid early.
Failing to put the agreement in writing could lead to acrimony later that harms relationships or entails court proceedings. An accountant could also be consulted to determine the tax implications for both parties.
Older crowdfunding platforms like Kickstarter don't offer loans per se but the money raised by a business through such a platform could be considered a form of lending. (Donors often donate in return for a gift of the company's product so effectively future revenues are being brought forward.)
There are, however, newer 'Crowdlending' platforms, like FundingTree, that offer peer to peer loans on a business-by-business basis. Potential lenders contribute loan funds at an offered interest rate and loan term based on the business pitch.
We believe this unlocks peer to peer lending which is normally unavailable to companies less than two years old but, from what we have seen, interest rates are typically quite high and the platforms generally charge fees on top of the interest paid to investors.
Presenting your Business to Potential Lenders
Securing funding for a new business can be difficult as, from a lender's point of view, it's a much more risky proposition than lending to a business with a robust trading history.
For that reason, we believe considerable care needs to be taken when putting together the supporting documentation. The goal is to present yourself and your business plan as a good proposition.
Our Top Tips for a Successful Startup Loan Application
Business plans should be thorough, well researched and include cashflow projections. These projections are needed to reassure lenders that they'll be able to collect their repayments so they should be supported by evidence, don't just pluck them out of the air.
Personal credit histories of the business owners/directors/partners should be in good health. Check your credit history with one of the main three credit reference agencies (Experian, Equifax, Callcredit) and, if it's in poor health, take steps to repair it before you apply for a business loan. Cancelling unused credit cards is one quick method for improving your credit score.
Personal CVs should be polished and provide evidence, where possible, of success in similar or related fields of business.
Assets, such as houses, should have been valued fairly recently in case they're required as security.
Independent experts, like an IFA, should have been consulted to ensure that you're pursuing the best kind of loan for your business.