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Borrowing money

To loan or not to loan: when to borrow for your business

Borrowing money

For most start-ups, the biggest obstacle is lack of capital. From the initial money required to get the business going, to the regular cash flow that sustains daily activities, funding is a constant thought on any entrepreneur’s mind. And for good reason too: a lack of funding is one of the most frequently cited reasons for start-up failure.

With this in mind, it’s not unreasonable for start-up owners to start looking at alternative sources of financing – leading many to turn to loans. These may help keep a business afloat in the short-term, but they can also lead to entrepreneurs being left with defaults and in debt. So should you seek out a loan as a start-up? And, if so, when is the right time to secure such a loan? As specialist small business accountants, allow the team at Tax Agility to explain.

Why do you need a loan?

Firstly, before deciding that you need a loan, it’s a good idea to ask yourself some pertinent questions. If you’re currently running a start-up in need of money, you’ll likely know the answers – but for those just getting started, it can be a good idea to reflect on how you approach the following questions:

How much do you really need?
A month-to-month cash-flow projection can help to work this figure out. Venture towards over-estimating rather than under-estimating, as the latter can cause problems down the line.

Will you qualify?
Knowing if you will qualify beforehand is important, as being rejected for a loan can hurt your credit rating and affect your future prospects.

Do you have the cash flow to repay the loan?
Don’t go to a bank without a clear plan of how the money will be used and when you can expect to repay it. Being able to reasonably demonstrate how you will return the funding will help immensely.

Is the loan going to help your start-up to grow?
If the loan is to rescue an unprofitable, ailing business, then it’s unlikely to help. It’s not worth tarnishing your credit score if the business becomes insolvent, nor would a potential creditor likely be interested. But if it’s to get you started, or to help your start-up take the next step, then these are more favourable reasons.

Are your personal finances and documentation in order?
The paperwork can often prevent a loan even going through in the first place. Before and during the process, make sure all your papers are in order and presentable. If it’s proving difficult, then consider hiring a specialist accounting and bookkeeping service to help you get everything together.

Are start-up loans a good idea?

On average, over 30% of business owners who secured finances through the UK government-backed Start-Up Loans scheme defaulted on their repayments. This is why banks are notoriously wary of start-ups, they are an unknown, and the unknown always comes with risk. Generally, lenders need to see evidence of capital, assets, collateral, proven capacity and an impressive credit rating before they will even entertain the thought of parting with their cash. Note that even if you fit that criteria, you still need to be clear about the purposes of the loan, demonstrate how you will repay it, and find ways to reduce risk to the lender.

Nevertheless, more and more people are starting up businesses. In 2016, nearly 700,000 businesses were created in the UK – up 50,000 in 2015. The number has been attributed to government-backed programmes such as the aforementioned Start-Up Loans scheme, as well as the wider Start-Up Britain initiative. Despite the risks, the loans scheme has provided more than £300m of loans to nearly 50,000 start-ups since 2012. Because of this, it may be worthwhile for any new start-up to explore this option as soon as possible.

When should you apply for a loan?

Those with an already existing start-up are eligible to apply for a loan from the Start-Up Loans scheme. However, as these businesses already exist, the emphasis on deciding when to apply for such a loan revolves around whether or not you can demonstrate the potential for growth. This can mean loans to rent new premises, purchasing new equipment, purchasing marketing materials or creating a website. If necessary, look to our start-up growth specialists to help you present your business in a favourable light.

In some cases, the scheme can also help start-ups with cash flow issues that hamper their growth potential. Causes of cash flow problems include late payments from clients or the attempt to fulfil an unexpectedly large order from a customer. In these instances, a loan can fill the gap until the normal finances catch up again.

Other avenues of funding

A loan isn’t the only option for a start-up. Other forms of funding include financial support from friends and family. This is known as ‘love money’ and can help in the early days. However, it’s important to remember that family and friends likely won’t have significant capital to offer.

Crowdfunding on websites such as Crowdcube has also become very important for start-ups. Crowdcube is particularly important within the UK context as it’s the world’s first equity crowdfunding platform. In 2017, 325 businesses launched using Crowdcube and £130 million of investment was made through the platform.

Lastly, angel investors have become a go-to source for eager entrepreneurs. Popularised in the UK by the TV show Dragons’ Den, it’s estimated that there are close to 20,000 business angels within the UK that invest £850 million a year. The majority of angels tend to have at least 5 to 10 years of experience in investing, and they serve as a valuable source of money for start-ups as well as a valuable source of networking opportunities.

You can find out more about alternative sources of funding from our blog ‘How to acquire funds for your business’.

Turn to Tax Agility – the small business growth specialists who can help

For new start-ups, the options are there to try and secure funding without going straight for a loan. However, for start-ups that already exist, loans can serve a crucial role in allowing them to grow their business and help them deal with cash flow issues.

There is no right or wrong ‘catch all’ answer to the question of whether a loan is suitable for start-ups. Each business is unique, so it is up to entrepreneurs – with the help of a financial adviser or accountant – to determine whether a loan would be good or bad for their business fortunes.

If you’re going to turn to an accountant for help, then you need to know you’re choosing the right one. At Tax Agility, we specialise in growing small businesses and start-ups, and we can help you decide whether a loan is beneficial for you and how to secure one.

To find out more get in touch on 020 8108 0090 or use our Online Enquiry Form.

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