Bank loan
This can be a short- or long-term loan that will also be secured on a business’s fixed assets. The bank agrees to lend the entrepreneur a set amount of money over an agreed time period, with regular repayments made usually each month by the borrower. The agreement can include a fixed or variable interest rate. A fixed interest rate is where the interest rate charged over the life of the loan will not change. A variable interest rate is where the rate of interest charged over the life of the loan could go up or down according to the current interest rates set by the Bank of England – known as the bank base rate. Repayments are based on a business paying back the original amount borrowed plus the interest charged over the term of the loan. Loans can often be for smaller amounts of money than a mortgage and paid back over a shorter time scale. The amount of the repayments need to be carefully considered when deciding how much the enterprise can afford to borrow.
This would be an investment option for the activity. However, it is unlikely that we will follow changes in the Bank of England base rate.
Bank overdraft
This is an arrangement with the bank whereby a business can spend a certain amount more money than it has in its bank account. It allows the business to borrow small amounts of money over a very short time scale. The total amount that the business can overspend is agreed by the entrepreneur and the bank – known as the business’s overdraft limit. If the business goes over, this limit will have a penalty charged and the interest rate will be higher. This can be a convenient way to access short-term funds, but it does tend to carry high interest rates thus making it an expensive option.
Other investors
There are now a great range of different financial institutions that will lend out money to businesses. They will all want interest to be paid back on the original amount borrowed. The higher the risk of the venture, the greater interest will be charged against the loan. Larger public limited companies are able to raise large amounts of capital by selling the debentures. Another way that people can start their own business is by seeking assistance from the Prince’s Youth Trust.
The Prince’s Youth Trust was founded in 1976 by Prince Charles and offers practical solutions to help young people to get their lives working. The Trust has helped many young people to get their business started when banks and other financial institutions have declined because they see the venture as too high risk. The aim of the Prince’s Trust is to help people ages 18-30 who are currently unemployed or employed in part-time or low-paid jobs that have a good understanding for an enterprise.
The Trust offers a start-up support which includes:
- a low interest loan of up to £4,000 for sole traders and £5,000 for partnerships
- a grant of up to £1,500 in special circumstances
- a test marketing grant of up to £250
- ongoing business support and specialist advice such as a free legal helpline
- ongoing advice from a volunteer business mentor
Venture capital
It tends to be very difficult to persuade banks and other financial institutions that your ideas are actually very good and do have the potential to earn the entrepreneur large sums of money in the future. Banks will have to weigh up all the pros and cons of investing in an entrepreneur’s venture. They will often require assets to secure the loan on. This means that if an entrepreneur’s venture fails, the bank will sell their assets and retrieve their money.
Venture capitalists are people who are prepared to take greater risks. They will invest in enterprises that have been turned down by other banks and financial institutions. However in return, they will charge higher interest rates and will want shares of the business (like what is commonly seen on the programme ‘Dragon’s Den’. The ‘Dragons’, who are already wealthy business owners, are willing to invest their money into an enterprise that takes their fancy, but in return they will want many shares in the business). The number of shares the venture capitalist requests depends on the size of the loan.
This type of finance is only suitable for limited companies that have sufficient shares to sell. Venture capitalists are attracted to rapid growth and are unlikely to be suitable for businesses that require an investment of less than £100,000, or an annual return of lest that 25% on the investment.
The disadvantage of this type of investment is the high rate on returns and the requirement to give up a large stake in some of your own business.
Business Angels are wealthy entrepreneurs who provide capital in return for being part of a growing organisation. If an entrepreneur want funds between £10,000 and £250,000 this could be an option of raising capital. One of the disadvantages is the entrepreneur has to develop a close working relationship with their Business Angel who will expect to “get their hands dirty” with the venture. Business Angels can determine how and when they receive their financial rewards from the business and this may take the form of a salary.
One advantage is that most angels are very experienced business people can they can be a useful addition to the business team.
Venture capitalists would not be an appropriate investment option as they would expect a return on the profits. They would not receive anything because all the profit would be going towards the school and activities on the final week of the school year.
Share capital
If you were to start a new private limited company, you would offer shares to selected people eg family, friends, or business acquaintances. These potential shareholders would buy a percentage of the business’s shares at an agreed price. The value of these shares is known as the share capital. The money raised from selling shares would be used to enable the business to start trading. The people who purchase the shares become shareholders, and therefore owners of the business, and will have voting rights within the business. Shareholders who invest in your business idea will be able to make decisions concerning the future of the business. The number of shares they hold will determine how much power they have in the business. If the business makes a profit, shareholders will be entitled to dividends. The amount each shareholder receives in dividends will, again, depends on how many shares each shareholder holds.
In small limited companies, the shareholders are usually the people who manage the day-to-day running of the business. However, not all shareholders have to be involved with the daily activities of the business.
In the future, if the business wants to raise further capital in order to expand or invest in more modern equipment, it could issue some further shares. However, these new shares can only be sold to people with a unanimous agreement of all the current shareholders.
Government grants
A grant is a sum of money that has been given to an individual or business for a specific purpose or project. A grant will only cover part of the total costs involved in the new business and could be between 15% and 75%. The remainder of the money will have to be provided by the individual or business.
There are some grants available for businesses, but the criteria are very specific and conditions vary. Examples could include people working in rural areas, businesses run by people younger than 25, or firms trading in a particular type of business. To secure the correct information on the correct grants available, entrepreneurs are advised to get in contact with their local authority or business advisor. Alternatively, they could contact Business Link and pay a fee to analyse grants that are available in their area.
Certain areas of the UK are set up as Enterprise Areas. A business located in or relocating to an Enterprise Area might benefit from one of several forms of Government assistance, including exemption form stamp duty, assistance from Community Development Finance Institutions, and neighbourhood renewal projects.
The Department of Trade and Industry recommends the Prince’s Trust and Shell Livewire as optional sources of finance, support and help for young people between the ages of 18 and 30 wanting to start up their own business.
Some businesses link up with academic organisations in order to co-run a project of interest to both organisations, giving both businesses access to local knowledge.
The Learning Skills Council provides grants for training and development.
The New Deal is a government strategy to get people back to work.
If Mr Keyte is the government in the school, all groups in the enterprise activity scheme started out with a £200 government grant.
Advantages and disadvantages of different sources of finance
If you borrow money from anyone, especially banks, they will expect regular repayments plus interest. This means you will ultimately have to pay back more than you originally borrowed.
If you borrow money from a bank or another financial institution, you don’t lose any control of you business and you don’t need to share any profits with the bank. If you receive help from a venture capitalist, it is likely that you will have to pay interest and you may lose some control over your business.
If you issue shares, you won’t have the liability of a loan outstanding but you may have to dilute the control of the business and you will have to share profits that you make in the future with your shareholders.
Obtaining finance
Any enterprise or entrepreneur who wants to obtain any finance is going to have to persuade the person or organisation with the funds that they will definitely be able to repay the money back in the future. In order to do this, they will need to produce a business plan which clearly indicates what your business is about.
Devising a potential business plan
If you are about to start an enterprise, your business plan needs to be the map of what you intend to do and how you will go about each stage. The plan will need to be presented to a variety of people including potential investors, shareholders, and your bank.
The purpose is to help these people understand your vision and goals for the venture. You will need to state how you will spend the money invested and how it will benefit either the lenders of the finance or shareholders.
This is the very first document that a new business will have to complete. It needs to look professional, accurate, and detailed in order to attract the interest of potential investors or financiers. These people are going to examine the business plan very carefully in order to determine the level of risk. They must ask themselves: “Is this enterprise worth investing my money in? What is the likelihood that I will receive a return on the investment?”
Each group had to produce a business plan to present to Mr Keyte at the start of the activity. Then he would decide if the venture would work, and would then issue the grant to the group to then go ahead and create their enterprise.
Presenting a potential business plan to potential financiers
There is no set format for creating a business plan. Many major banks and financial institutions can offer CDs with blank documents that the new entrepreneur can use in order to present their business plan.
Most business will include the following information:
-
Introduction – a brief summary of what the business hopes to achieve. It should not be too long, but sufficient enough to attract the attention of potential investors and financiers.
-
Organisation chart – to show each person’s individual responsibilities and position in the management structure. New businesses may be suggested to have a flat structure, meaning communication between employers and departments are easier.
-
Competitors – A description of the business’s competitors and how the product or service will compete against them.
-
Customers – Who are the customers and why would they buy the product/service?
-
Marketing plan – You have to say how you are going to market your product/service to potential customers, outlining any assumptions that you have made.
-
Credit control – How is the business going to manage credit control, monitor debtors and creditors? How will it manage stock control and other expenditures? What procedures will you put in place to ensure that these difficulties are avoided? If a business is seeking finance, you must include:
-
Loan repayments – How will the loan be repaid? When will potential investors get their money back?
-
Cash flow forecast – This will show how much money the business expects to have flowing into and out of the business. It should clearly show the amount of funding needed and clearly state and emergency plans that are in place should the business encounter any financial problems.
-
Forecast financial accounts – These two documents will forecast potential profit and assets held within the business.
Winning support from potential investors
If you are able to present all of your documents to a potential investor well, you will be on your way to securing finance for your enterprise venture.
It is very important to be completely honest and realistic with your investors when you are discussing predictions concerning revenue and expenditure. The third party will have a better idea of any potential hazards that could arise and can advise accordingly.
If it seems like people are being very negative and pessimistic about the initial plan or idea, they are not trying to be. They are merely being realistic. You will also need to make sure that all your facts and figures are as accurate as possible. This will show your potential investor that you have one of the most important skills an entrepreneur can have – the ability to organise and use financial information correctly.
