14 Types of Business Finance
When your business needs finance, you’ll discover that there is a vast array of types and sources available, all serving different purposes.
Business Finance is typically broken down into three distinctive categories, short-term finance, medium-term finance, and long-term finance. Depending on where you are in your business journey, you may need more than one type of finance at any one time – often it’s not a one size fits all.
Your bank, local growth hub or finance broker can give you further advice on which type of finance is right for your business.
Short-Term Finance Options – for less than 12 months.
Short-term funding is used to help during times when cashflow is lower than you would like it to be – you might be waiting for payment of an invoice or have an opportunity to stock up at a good price and need extra cash to cover the expenses.
Check out what Business Loans we can offer you.
1. Business Credit Cards & Overdrafts
Business credit cards are intended for business use, rather than personal use. They provide a useful stop-gap and are available to businesses of all sizes.
If you’re using a credit card for finance, be mindful of the interest rates as they can be expensive.
An overdraft is an approved amount of extra funds (or ‘line of credit’) and is attached to your business transaction account. Use your overdraft whenever you need to and back what you can when you can, as long as the overdraft stays under the approved limit.
Overdraft facilities can be particularly appropriate to fund short-term working capital cycles, such as stock, debtors, and work-in-progress.
Your bank will be the best place to source these types of finance.
2. Invoice Financing
Invoice finance is a form of borrowing where a business borrows against its outstanding customer invoices. If you provide goods or a service to another business where payment is delayed for 30, 60, or even 90 days, invoice finance is a good way to bridge this gap.
As a rule, the debt is secured against the outstanding invoices (i.e., the “debtor book”). Sometimes the debt is secured by a more general charge over company assets.
The overall cost of invoice discounting should be fully understood before you enter into it.
3. Trade Credit
Trade Credit is where your supplier offers you 30 or more days to pay them. It helps you manage your cash flow by giving you time to deliver the goods to the customer and invoice them for it.
It’s worth bearing in mind though, you might need to pay upfront until you build up a record with your supplier.
4. Merchant Cash Advance
This option uses the sales taken by your card payment machine to release a sum of money to you in advance of future receipts. You then pay a percentage of your card receipts back to the merchant until the debt is repaid.
This can be useful for seasonal businesses as the percentage is fixed but the amount will vary in those quieter months, and the repayment is less.
Be aware that not all merchant service providers offer this.
Medium Term Finance Options – 1–5 years.
Medium-term finance options are normally for larger items or multiple needs, usually associated with business growth. A combination of medium-term finance options is often used to get the best solutions for your business.
5. Asset Finance
Asset finance is commonly associated with purchasing new equipment or vehicles. This form of finance is specific to the acquisition of assets, and the asset will either be ‘owned’ by the lender (for example, an arrangement where the lender purchases the asset on behalf of the business but retains title until the loan is repaid) or be secured against the particular asset being purchased. Asset finance may also enable a business to use its existing assets as a form of security against a new loan.
It is important to fully understand all the costs involved in asset finance, including interest and fees (front end and/or back end) as well as the impact the finance will have on cashflow (for example is there a balloon payment involved at the end of the finance term).
6. Lease Financing
A type of funding used to purchase larger assets like kitchen equipment, motor vehicles, and other items that will still have a good value at the end of the finance term.
The asset is purchased by the finance company which leases it back to the business in return for a monthly repayment amount. The item remains in the ownership of the lease company and the business owner is granted the right to use it but also takes responsibility for maintaining the item including its insurance and repairs.
At the end of the term, it’s likely that you will be provided with an option to pay a balloon payment and buy the item outright. It could also be traded in for a newer version on similar terms.
7. Hire Purchase
Like leasing, hire purchase items don’t belong to you until the final instalment is paid but you have the right to use it. You will need to pay a deposit, often around 10%, but there is no balloon payment at the end.
The monthly repayments are made up of interest and capital from the loan so the balance will be reduced to nil. When you have finished paying, the item belongs to you.
8. Medium-Term Business Loans
Your bank will still be the first port of call for seeking business funding. However, over recent years many banks have tightened their lending criteria and businesses may no longer be able to obtain all, or any, of the finance they feel they may need.
It’s also worth noting that if you are running a start up with little or no trading history, you’ll find it even harder to source this kind of finance from your bank.
There are a large number of non-bank, online lenders, many of whom can give quick decisions by using automated credit assessment tools.
If you don’t meet the bank’s criteria, or prefer a more personal service, you can contact your local Community Development Financial Institution (CDFI). These are mission-led organisations that support businesses that have potential but need more support than their bank can offer. The South West’s CDFI for business is SWIG Finance.
A medium-term loan is typically repaid over 5 years and funds can be used for a range of purposes. Monthly repayments are based on interest and the capital balance of the loan and the loan is paid to nil.
At SWIG Finance, we offer unsecured business loans, although you will need to provide a debenture and a personal guarantee. Our business loans are available to South West-based SMEs who have been trading for more than two years.
As the South West’s dedicated Business Support Partner for the Start Up Loans Scheme, we also have Start Up Loans available to entrepreneurs who have been trading for less than three years. These loans are personal loans to be used for business purposes.
Long-Term Finance Options – 5-25 years
Long-term finance options are used for much larger borrowing requirements like buying premises.
9. Venture Capital Funding
Venture capital is geared at younger and smaller businesses and involves investors taking equity stakes in exchange for upfront cash injections.
With venture capital funding, investors are looking for businesses with strong growth potential often in a niche or high-growth sector. These investments are characterised as high-risk/high-return opportunities.
Often the investment will come with some hands-on help as the investors are often highly experienced in the sector or industry.
There can be a lot of benefits in having this experience but in return, you need to give away a percentage of your company and therefore forfeit having 100% control.
Depending on the investor’s exit agreement, this category of finance may also sit under medium-term finance.
10. Commercial Mortgages
Commercial mortgages work in a similar way to residential mortgages. Because the loan is secured against the property, interest rates are generally lower but you will need to find a large deposit, which is typically 30% of the mortgage value.
Lenders often specialise in certain sectors, such as property investment and development, retail, and manufacturing premises. If you are considering this option, we recommend that you speak to a reliable commercial broker. Your bank may also be able to help you.
11. Private Equity Funding
Similar to Venture Capital, Private Equity investment also involves providing shares in your company in return for capital, however, due to the nature of the investment, Private Equity is targeted at more mature businesses.
Equity investments can be complex and appropriate legal advice should be sought. It will generally be appropriate for there to be a shareholder agreement between those holding shares (i.e., those before and after the investment). It is important to fully understand the implications of all investments and their accompanying documentation.
12. Long-Term Business Loans
This is really the same as a medium-term business loan but over a longer term. Larger loans are usually secured against assets.
Monthly repayments are made up of the interest charged and a portion of capital to repay the loan during the agreed term.
Alternative Funding Options
The Alternative Funding market has grown significantly over recent years. You’ll find that utilising these forms of finance depends greatly on your business model and your product or service offering.
13. Crowdfunding & Rewards
Crowdfunding is when funds are raised by a large number of individuals contributing small amounts in return for an interest or fee return and/or ‘rewards’. It is an increasingly popular way to fund businesses, especially if you have a good story to tell.
Typically, rewards take the form of merchandise or benefits related to the business in proportion to the amount contributed.
Finance from such sources can be perfectly legitimate but, as always, great care should be taken to understand the overall cost, whether there is any implication in terms of present or future finance providers, and whether there are any conditions or covenants that do not suit your business.
Sites like Crowdfunder and Crowdcube make it easier to be able to raise finance this way and will support you in doing so.
Crowdfunding is time-consuming and often relies on a solid marketing campaign plan. You should ensure that you have a strategy in place before you begin any crowdfunding campaign.
14. Small Business Grants
Grants are non-repayable (subject to certain conditions) sums of money, usually from the government, that can be awarded to businesses to help meet specific needs. The non-repayable aspect is attractive but there is a multitude of schemes out there and most have very particular eligibility criteria which can exclude access to them.
The type of grants you may be eligible for depends on the nature of your business.
Sourcing grants is another time-consuming activity, and in doing so you should not lose sight of the primary need for a business to be financially successful by means of profitable trading.
If you are interested in finding out more about grant options available, you can perform a grants search on Grants Online.
About SWIG Finance
SWIG Finance is a non-profit company that supports viable South West businesses that can’t secure sufficient funding from their bank. By empowering underserved start ups and SMEs to overcome their financial barriers, we are working to create a more balanced financial ecosystem.
We’re growing every year. In 2021/22, we lent £10.8m to 502 businesses, helping to create and secure over 1,000 jobs and generate £32.3m. For more information visit our Social Impact Report.
If you’d like an informal chat about your funding requirements, get in touch with our friendly and professional team to see how we can help: email@example.com / 01872 227 930.