As a founder, one of your principal responsibilities is raising capital. When it comes to fundraising, you will likely have to consider the tough decision of choosing how much of your startup you’re willing to give up. However, many businesses want to raise cash without diluting their equity.  

Equity-based financing does, of course, have many benefits: you don’t have to make regular repayments as with debt, all of the capital raised flows into the growth of your business, investors can bring valuable skills and connections, and it can path the way for future fundraising.

However, it’s possible that equity financing might not be suited to your startup. So, let’s take an in-depth look at the advantages and disadvantages of the different debt financing options for businesses.

Bank Loans

Best suited to startups with consistent cash flow.

Until the Credit Crunch, banks were the principal source of finance for most business startups. Bank loans fall into two types; unsecured business loans and secured business loans, which are typically taken out from a bank or building society.

Advantages of Bank Loans

  • Banks are convenient, accessible and familiar. If you have been a bank customer for years, your bank becomes a comfortable and personalised service to consider.
  • Some secured business loans are guaranteed against effects such as your home, the stock you’re purchasing, and on the assets belonging to the business. Depending on the assets you can put up as security, as well as your circumstances, you can borrow substantial amounts.
  • Many banks have a fixed interest rate and no application fee for the loan term time.

Disadvantages of Bank Loans

  • Secured business loans are approved when the founder agrees to a personal guarantee, substantiated with an asset, such as property. So in some instances, founders quite literally may be asked to bet the house they live in if the business fails, which can result in devastating losses for a founder.     
  • Bank loans are best suited for startups with reasonable cash flow, as banks give preference to businesses that they can gauge profitability and credit history of. This means even more difficult applications for the startups that don’t yet have decent cash flow.             
  • Banks usually have long lists of prerequisites that a business must meet before they approve a loan, alongside a lengthy application process.  
  • With unsecured loans, the amount payable, and the interest rate on offer will depend on your personal credit rating and the creditworthiness of your business. As this type of loan isn’t secured against your home or business, the amount you could borrow will probably be relatively small.
  • Some banks charge for early repayment.
  • There has been a reasonable level of criticism recently around banks’ lack of propensity for risk-taking, particularly when it comes to startups.
  • Fixed repayments denote that, when cash flow is changeable, you may struggle to pay the bank.

How to Get Bank Loans

Shop around and find the best deals on offer from banks. Major UK banks such as NatWestHSBCSantanderYorkshire Bank, and Lloyds Bank all supply small business loans.  

Government Startup Loans

In the UK, these are only suited for UK-based businesses that have been trading for less than 24 months.

One of the best schemes in the UK for new businesses looking for early capital is the Government-backed start-up loan scheme. The programme allows each director in the company to take out a loan up to £25,000 per director with an annual APR of 6% over a five year period. This scheme is a game-changer for those entrepreneurs who may not have access to wealthy friends and family. Often entrepreneurs will use the capital to build out their initial piece of technology, make their first production run or purchase an essential asset for the business.

Advantages of Government Startup Loans

  • In addition to capital, you are offered up to 12 months of mentoring support and access to a variety of particular business offers.
  • Fixed interest rate.
  • Free application support.
  • No application or set-up fees.
  • No repayment fees.
  • There is a six month principal repayment holiday so that you can use that time to increase your revenues to afford the repayments.

Disadvantages of Government Startup Loans

  • Can only borrow up to £25k (per director), so it’s unsuitable for startups looking to raise a larger amount of capital.
  • Some business types are ineligible, including banking, money transfer services, and property investing.
  • A startup loan is personally owned by the founder who takes it, not the company.

How to Get Government Startup Loans

Discover more about Government Startup Loans directly from the Government website here.

Invoice Financing

Best suited to B2B startups that sell on credit, have a decent range of debtors and indicate healthy growth potential. However, there are a wide range of providers in the market, so even if you are an early-stage business, there will be providers who will want to chat with you.

If you need additional money for cash flow purposes (rather than in a few months when a hefty invoice is due to be paid), invoice financing may be appropriate. With invoice financing, a third party ‘buys’ your unpaid invoices from you and lends you money against their value.

There are two types: factoring and invoice discounting. With factoring, the invoice financier (such as Market Invoice) collects the money owed to you by your customers. So you sell unpaid invoices to the financier, but for a percentage of the full face value of the invoices (typically 85%). When the end consumer pays the invoices, all the money goes to the financier. From that cash, they keep 85% they’ve already advanced to you and deduct their fees (plus interest) from the other 15%, before paying the remainder to you.

With invoice discounting, the invoice financier lends you money against the value of your unpaid invoices, for a fee, but you collect payment from your customers as usual. You then use this money as it comes in towards repaying your loan.

Advantages of Invoice Financing

  • Invoice financing allows a business to borrow money against the revenues owed to it by its customers. In lots of industries, companies can take a long time to pay their balances, so invoice financing helps support the selling company’s cash flow in the short-medium term. It, therefore, enables the company to invest in operations, hiring staff and growing, without having to wait on their customers to pay their balances.
  • Rapid access to funds (24 hours in some cases). This is hugely beneficial for those businesses whose debtors have payment terms of 30 days upwards.
  • No requirement to provide any property or other assets as collateral.
  • More flexible lending practices and conditions than banks.
  • Interest is only payable on the borrowed amount.
  • Keeping track of invoices and contacting customers is outsourced – in factoring financing, the factoring business keeps track of your invoices, freeing you up for more important tasks.

Disadvantages of Invoice Financing

  • There is a cost accompanying invoice financing, meaning that you won’t collect the full income from the service you supply, as the invoice financing provider will take a cut for monthly interest rate and service fees.
  • Providers will only lend capital against invoices due from clients or customers they anticipate paying.
  • Some types of invoice financing are disclosable to your customers.
  • Only suitable to address the problem of insufficient cash-flow.
  • Depending on your arrangement with an invoice financier, your customers may be aware that this funding practice is in place. Factoring providers are in control of collecting payments from consumers, so consumers will deal with them directly, potentially damaging relationships you have with them.  
  • For businesses with small margins, invoice financing can reduce your profits as these services come with a fee.

Finding Invoice Financing

For businesses that are perhaps better suited to an alternative to Equity Crowdfunding, such as invoice financing, Seedrs has partnered with Swoop Funding. They are a platform matching businesses with their 1000+ funding providers across the UK and Ireland. At Swoop, one of their most popular facilities secured through their platform is invoice financing. Some providers within the Swoop network will even fund a signed SOW (Statement Of Work) which has been a game-changer for a lot of professional services businesses. Providers will also fund contracts outside of the UK once the money is flowing back into a UK bank account. Find out more on their website here.

Loan-based Peer-to-Peer Lending  

P2P lending websites connect creditworthy businesses that are looking for a loan, with people who are wanting to invest. Compared to banks, lenders can earn higher interest rates and borrowers can borrow money at lower interest rates.

However, the interest rate on offer will depend on your credit score for a personal loan, or the financial performance of your business.

Advantages of Loan-based Peer-to-Peer Lending

  • Loan-based peer-to-peer platforms pay funds a lot faster than going through a bank. Once approved, they can generally be paid out within two weeks.
  • Fast online application process compared to those for bank loans, for example.
  • Most of the leading loan-based peer-to-peer lenders in the UK offer accommodating loan terms such as choice of repayment term length, and/or no early repayment charges.  
  • Maintaining control and ownership of the interests in your business, meaning that you continue to make the decisions and keep all the profits.
  • When you pay off the loan, your liability is over.
  • Creates more tax deductions, which can have a huge difference as your company grows and yields positive revenues.

Disadvantages of Loan-based Peer-to-Peer Lending

  • The burden of repayments, no matter how well you’re doing (or not).
  • Some providers’ financing terms can change over time, including interest rates, which can drastically change your repayment terms.
  • No potential presale/audience building aspect that you receive in other forms of crowdfunding such as equity or rewards.
  • You are held personally responsible for repayments if the business is unable to repay the loan. In unsecured loans, personal guarantees will apply if you default on loan repayment. Secured loans can be secured against property, or at the very least, it will have to be personally guaranteed by the directors (who usually have assets) and secured against business assets (e.g. equipment, stock).
  • Charges if you fail to keep up with repayments.
  • Any late or missed repayments will be recorded on your credit file, possibly making it more difficult to receive credit in the future – for both secured and unsecured loans.

Finding Loan-based Peer-to-Peer Lending

Swoop Funding, connects businesses in need of finance with over 400 lenders, including loan-based crowdfunding platforms such as Funding Circle and Growth Street – check out their website here.

Finding the best form of financing for your startup can have a profound and lasting influence on how your business runs, and it will likely change over time, as you grow. Plenty of companies make use of combining debt and equity financing, according to what they need at the time. To find out more about equity financing, take a look at our guide: Equity-Based Financing Options for Startups.

This post was contributed to by Ciaran Burke, COO & Co-Founder, Swoop Funding. Swoop simplifies and speeds-up access to loans, grants and equity funding for businesses in the UK and Ireland.