What Is the Best Financing Option for a Business?

“You’ve gotta spend money to make money,” as the old adage goes. But what if you don’t have any money to spend? That’s when a third party can come into play to offer you a financing option that will help your business reach its full potential.

But there are so many financing options on offer! How does a loan differ from an investment or a grant? Don’t worry – we’ll take a look at the various financing options that a business can use to bolster its bottom line.

Before we do get started, however, we’ll stress: do your research on each and every company/individual you’re considering when looking at financing options. There are some deceptive people out there who are looking to use equity, interest rates, and repossession clauses for their own benefits.

There are hundreds of thousands of financing option providers out there, so if one looks appealing, Google it as much as possible. It won’t take long to find some customer testimonials, which will help you head into an initial meeting feeling confident in your knowledge of a provider’s legitimacy.

What Does ‘Financing Option’ Mean?

When we use the term “financing option,” that isn’t a unique phrase referring to a specific thing, like “stock options.” We’re literally referring to the many options available to small business owners that can help them finance their dreams and goals.

The Best Financing Options for Businesses

You might be surprised at just how many financing options there are available for budding businesses! While not every business can take full advantage of each option, let’s go over the most common routes that you can take to get your business off the ground.

• Bank loans – best for traditional loan payment
• Business line of credit (also known as revolving credit facility) – best for long term loans
• Merchant cash advance – best for passive repayment
• Invoice financing – best for quick influxes of cash
• Angel investors – best for building a strong business relationship
• Venture capitalist investment – best for lightning-in-a-bottle businesses
• Research & development/small business grants – best for businesses with noble prospects
• Crowdfunding – best for small-scale businesses

Bank Loans – Best for Traditional Loan Payment

This is the most “classic” form of financing. Bank loans have existed for as long as banks themselves, and are a common way to afford some of life’s pricier endeavours, like buying a house or starting a business. The exact process will depend on the bank, but generally, you’ll undergo an interview and vetting process to ensure you can pay back your loan eventually.

Bank loans can be split into short-term and long-term loans. Long-term loans are much larger, but you’ll have more time to pay them back. Short term loans are smaller amounts of money with a smaller time window, but they also come with higher interest rates.

You probably won’t be surprised to hear that bank loans are incredibly rigid. A bank loan is a legal contract, so you really have to consider every bit of fine print when applying for one. Renegotiating a loan is a nightmare, to put it lightly, so you’ll want to make sure you’re on top of everything before even going into the meeting. It can also take a while before you’re approved, what with all the red tape.

Of course, it’s not just banks offering loans. There are specific loan companies that serve the same purpose as bank loans, and you might find that one of them suits your needs a bit better. However, the same general rules will apply when using a loan company, so it would be a similar process in either case.

Another factor to strongly consider is the interest rates at the time of setting up your loan. If you jump the gun and grab a loan when interest rates are high, you’ll lose a lot more money in the long run, so patience and research are key. Also, as you may know, banks will ask for some collateral in the case that you can’t pay for your loan. This could include your house, which is obviously a pretty serious call to make.

Of course, if you have all the faith in the world that your business will make enough money to pay back the loan, a bank loan (or a loan from another provider) might be all you need, as it can give you all the investment you need in one hearty lump. Just be realistic!

Business Line of Credit (Also Known as Revolving Credit Facility) – Best for Long Term Loans

The easiest way to think of a business line of credit (BLC) is by picturing a gradual loan instead of an “all-at-once” loan. To get a business off the ground, you might want £50k all at once for a variety of things – but when your business is somewhat established and looking to grow, you might want to spread this out a bit more.

For example, say you run a bakery. You need to renovate the plumbing at your current location immediately (£7k), but also have your eye on expanding your business once a certain location goes on the market in three months (£25k). If you were to take all of this out as one £32k loan, you’d be paying interest on £25k that you don’t need just yet. But if you applied for these two amounts to be deposited into your bank account separately according to when you needed them, you could save a lot on interest.

This approach can also help you forge a longer-term relationship with your BLC provider, which might lead to future engagements with lower interest rates as you develop trust. However, on the whole, the amount attainable through BLCs is a bit lower than what you can get with traditional loans.

You can apply for a BLC through a bank, loan agency, or other lending institution. Much like a loan, you’ll need to verify your current cash flow, credit scores, time in business, and possibly some other things depending on who you’re talking to. Make sure to read the fine print, though, because a lot of BLC providers are somewhat less than wholesome, taking advantage of deceptive interest rates to put people in financial chokeholds.

Merchant Cash Advance – Best for Passive Repayment

A merchant cash advance (MCA) is a bit like a bank loan with less red tape. Rather than being given by a bank, merchant cash advances are often given by private companies. If your business finds itself hard up for cash, you may want to approach an MCA provider for help.

MCA providers can give you a sizable amount of money – within the low hundreds of thousands, if you need it. And as long as you pay the money back, they don’t really care how you use it. An MCA can also be approved in a day or two, meaning that if you’re in a particularly tight spot, it might be just what you need.

The repayment method is quite unique – the MCA provider will simply take a sliver of any credit card payments you receive until your debt is paid off. This is nice in that you don’t have to actively worry about making payments, but the MCA provider may impose daily quotas. And since these must be done through a credit card machine, your business will need to have a credit card payment option.

Like bank loans, MCAs are not to be undertaken lightly. Interest rates can be astronomical, so this commitment should really only be made if it’s a necessary step, and not a passing fancy. For example, National Funding, a popular MCA provider, imposes an average of 26% onto its investments – meaning that for every £1,000 you get, you’ll have to repay £1,260, with the additional £260 coming straight from your profits.

Invoice Financing – Best for Quick Influxes of Cash

Of all the options on this list, this one might seem the most unfamiliar. Well, at its core, invoice factoring is the process of getting an advance on your customers’ unpaid invoices. Customers can take weeks or even months to pay off an invoice, which means that a lot of money that technically belongs to you is spending a lot of time in limbo. That’s when invoice factoring companies will buy those invoices off of you, meaning they’ll later receive the final payment from your customers.

These companies will typically buy your invoices for around 90% of their worth, paying the final 10% once they’ve received payment, minus their fees, which are usually between 0.5-5% of the total invoice value.

Obviously it’s nice to get an advance on the invoice, but permanently losing out on that 0.5-5% can frustrate some business owners. Still, no financing option is completely free, and a flat rate can be preferable to a constantly ticking interest rate.

Since these companies are acquiring the invoices of your customers, it’s only fair for said customers to be looped in on the whole process. That’s why the invoice financing company may touch base with your customers and let them know that they’re now the owner of the invoice. While this isn’t too bad, there was a stigma a while back that only poorly managed businesses relied on invoice financing companies, which didn’t reflect too well. This has largely gone away, but we can’t speak for everyone!

If your interest is piqued, take a look at the top 10 invoice factoring companies in the UK.

Angel Investors – Best for Building a Strong Business Relationship

If you’ve ever seen Dragon’s Den, skip this section – you know exactly what’s going on here (don’t actually skip this section though). If you haven’t seen Dragon’s Den, an angel investor is a wealthy individual who (hopefully) takes an interest in your business and wants to help out. If you’re not a fan of the bureaucratic process of banks, a conversation with an angel investor over dinner may be a more fluid option.

While it helps to tick off certain quantifiable boxes, like projections and sales figures, an angel investor might just have a good feeling about your business and decide to jump aboard, which would never happen with a bank. And if they care enough, they might bring their own business know-how along with them, which can help you blaze ahead.

What do they stand to gain from this investment? Well, unless they’re an outstandingly generous individual, they’ll want a piece of your business’s pie. They can say something like “I will invest £20,000 into your business, but I want a 33% stake in the company.” This means they’re entitled to 33% of the profit, and 33% of the decisions that take place. If they’re particularly generous/greedy, they can even ask for a majority stake, meaning they’ll be steering the ship.

A potentially sticky problem that can arise here is the fact that you’re dealing with an individual. With banks, the entity you’re dealing with stays more or less the same over the years, but with an angel investor, you’ll need to maintain a healthy relationship with an individual, whose temper and interests can change depending on the day.

Venture Capitalist Investment – Best for Lightning-in-a-Bottle Businesses

At first glance, venture capitalists (VCs) might seem very similar to angel investors. And that’s a fair assessment! They actually pretty much follow the same system, but while an angel investor is an individual, a VC is an organisation. And these organisations like to throw money around, with the average venture capitalist deal closing at just under $10 million. So if you do secure their interest and funding, take it as a sign that your business is going to boom, as these guys know what they’re doing.

Obviously, it takes a lot of proof to earn such a large investment. Both your own and the venture capitalist’s projections will need to show massive room for growth, and you’ll need to prove that people love your product – and even then, you’ll have very slim odds of actually nailing down an investment so large. A small tip: VCs tend to like going for tech companies.

Much like those who work with angel investors, anyone who takes an offer from a venture capitalist firm will be surrendering a bit of equity in their company, which will mean you’ll have less control and can gain less profit. Venture capitalists are also usually a lot more aggressive than angel investors, as they will often take a board seat and can even offer to buy you out if they get hungry enough.

Research & Development/Small Business Grants – Best for Businesses With Noble Prospects

That “best for businesses with noble prospects” title might seem odd to you, but hear us out. There are two main reasons why grants are awarded: one is a business’s ability to greatly improve society (no pressure), which can make it a good candidate for something like the Innovate UK grant. The other reason is simply compassion, and this might cover things like COVID relief, taking on an apprentice, or starting a business while unemployed.

Unlike most other financing options on this list, these grants don’t require any kind of return on investment. They can be seen as general investments in the economy, as when your business reaches its full potential, it may be able to give more back to society than the government/grant provider ever put in.

Obviously, if a government or organisation invests in your business with no expectation of an immediate return on that investment, it’s a great sign that your business has potential to do impressive things. Consideration and/or approval for one of these grants should be a confidence booster if nothing else!

These grants aren’t going to fall out of the sky and into your lap, however. You’ll need to seek them out and apply for them. Even then, you’ll have to tick a lot of boxes, and they can be very competitive to secure. The other “problem” is that these grants don’t typically award exorbitant amounts of money. Beggars can’t be choosers, and a free £10k is a free £10k, but it’s more of a helpful boost than a fix-all investment.

Crowdfunding – Best for Small-Scale Businesses

This is one of the more recent methods of financing a business or project. Crowdfunding is the act of taking investment from a large number of people (a “crowd,” one might say), and putting that toward your business. Much like a charity event, this method can help the investment grow quickly, as your friends and family contact their friends and family, and so on.

You’ve likely been exposed to this type of financing in your everyday life in the form of a Kickstarter project or GoFundMe goal. These can be used for anything, from funding a video game’s production to helping someone pay off their medical debt. This is a strength of crowdfunding – there’s a chance it can snowball via social media, provided your concept is sound.

However, the common denominator in all successful crowdfunding is that people believe in what they’re funding. To secure the capital you need, you’ll have to make sure that your multitude of investors believe in your business as much as you do. This is the case with most financing options, but with the volume of individuals needed for crowdfunding to work, it’s a lot more important here.

You’ll also need to be much more active in promoting your crowdfunding campaign, as not many people will see it if you’re not constantly pushing it under their noses. Annoying? Maybe. But certainly effective!