What are the different types of business finance?

Securing the right funding can be the difference between a thriving business and one that struggles. However, with numerous types of finance available, it can be challenging to know where to begin. 

This comprehensive guide breaks down the different business finance options into short-, medium- and long-term solutions to help you work out what's best for your business.

Short-term business finance options

Short-term finance typically refers to loans with a term of less than 12 months.

1. Business credit cards

A business credit card provides a flexible way to borrow the funds you need to cover everyday business transactions or larger expenses. Like a personal credit card, a business credit card comes with a set credit limit that you can borrow against as needed. The difference is that business cards usually offer much higher limits than personal ones, giving you more flexibility to cover expenses and manage cash flow.

Monthly repayments are flexible, as long as you meet the minimum amount. However, if you don’t pay off the balance in full each month, your provider typically charges interest on the remaining balance. 

Business credit cards often come with additional perks such as cashback, air miles and travel insurance. Note that you may have to sign a personal guarantee when applying for a business credit card, making you personally liable for the debt if the business can’t repay it. 

2. Business overdrafts

If you have a business bank account, it may include a business overdraft. You can use this to cover unexpected expenses whenever required and there’s no set repayment date. However, interest rates can be high, so it’s best to repay your overdraft as soon as possible.  

The size of overdraft you’re offered typically depends on your annual turnover and business credit record.

3. Invoice finance

This option allows you to borrow money by using your business’s unpaid invoices as collateral. You can typically borrow up to 95% of the value of your customers’ invoices and you repay this once your customers have paid up.

If you opt for invoice factoring, the lender collects payment for your invoices directly from your customers and then repays you the remaining balance, minus fees. But with invoice discounting, you must collect customer invoice payments yourself. You then repay this money to the lender, keeping the portion that wasn’t part of the finance agreement, less any fees.

4. Line of credit

A business line of credit allows you to borrow money whenever needed, up to your agreed credit limit. You only pay interest on the amount borrowed. 

Many business lines of credit can be revolving, which means you can draw upon the funds again once you’ve repaid them, without going through another application process. Other lines of credit only last a set amount of time.

You can choose from either secured or unsecured business lines of credit. If you opt for secured, you must use an asset, such as your car or work equipment, as security. If you fail to repay your loan, the lender can seize the asset to recoup its money. This makes it riskier for the borrower, but it’s often easier to qualify for secured credit than unsecured. 

5. Merchant cash advance

If your business takes regular card payments, a merchant cash advance can provide a quick cash injection when you need it. Your provider gives you a lump sum of cash up front based on how much money your business makes from card sales each month.

You then repay this amount through a percentage of your card sales. The provider automatically collects these repayments, alongside the necessary fees, and the amount you repay fluctuates in line with your income. This means that you pay more when business is booming and less when things are quiet. 

6. VAT loans

Another short-term finance option is a VAT loan. This can help spread the cost of your VAT bill over a matter of months. If you’re approved for a VAT loan, the lender pays the funds directly to HMRC to cover your bill and you then repay the loan over three, six or 12 months, with added interest. 

Your business must register for VAT if its taxable turnover exceeds £90,000 in a 12-month period. You must submit a VAT return to HMRC every three months.

7. Working capital loan

A working capital loan is typically taken out over the short to medium term and can help you finance your day-to-day operations, such as payroll, rent and stock. You can choose from secured and unsecured loans, and you usually repay the amount borrowed within 12 months, although this can stretch up to two years. 

Medium-term business finance options

Medium-term finance options typically last between one and five years. 

8. Unsecured business loans

An unsecured business loan enables small businesses and entrepreneurs to borrow a lump sum of cash over a fixed term. You must repay the amount borrowed, plus interest, in monthly instalments and there’s no requirement to offer an asset, such as property, as security. 

However, this means unsecured loans can be harder to get, and you may be asked to sign a personal guarantee. Borrowing sums tend to range between £1,000 and £750,000, but this depends on your business’s annual turnover and credit history. You typically need a good business credit score to borrow higher sums at more competitive interest rates.  

9. Startup loans

Some lenders may be unwilling to lend to new businesses, but this is where startup loans come in. Designed specifically for businesses that have only recently started trading, startup loans provide a lump sum for cash flow, rent, equipment or wages. 

The government’s Start Up Loan scheme, for instance, provides funding of between £500 and £25,000 to UK businesses that have been trading for less than 36 months. 

10. Asset finance

If you need business equipment, machinery or vehicles, but can’t afford to pay for it outright, asset finance is worth exploring. There are several types of asset finance, but all types allow you to spread the cost of the asset over time. 

Depending on the type you choose, you may need to pay an initial deposit, and at the end of the agreement, you might own the asset outright, return it or renew the contract. 

Examples of asset finance include:

• Hire purchase – Here, a lender buys the asset and you lease it from them. You make regular payments over the agreed term and once you’ve completed the payments (including interest), you can pay a purchase fee to own the asset outright

• Contract hire – You typically use this option to lease cars and vans. The provider deals with maintaining the vehicles, so you don’t have to, and once you’ve completed your payments and the rental period has come to an end, you can either extend the term or return the vehicles

• Finance lease – The provider buys an asset for you and leases it back to you. You then make monthly repayments, including interest. Once the term ends, you have the choice of continuing to rent the asset, returning it or selling it to a third party

• Equipment lease – Designed to spread the cost of equipment, you make regular payments over the agreed term. Once the contract ends, you choose whether you want to extend the lease, return the equipment, upgrade it or make a final payment to buy it outright

• Operating lease – Here, you obtain equipment for a limited period and make regular payments over that time. During the rental period, you can upgrade to a newer model if desired

11. Crowdfunding

Crowdfunding is a way of obtaining finance from a group of individuals, typically via an online platform, such as Crowdfunder or Republic. In exchange for their investment, you could offer a share in your business or a reward, such as a product sample, or the investment might simply be a donation. 

However, bear in mind that crowdfunding isn’t right for every business – to have the best chances of success, your business needs to have good growth potential and offer an innovative idea. It’s not suitable for more traditional business models. 

12. Peer-to-peer lending

Peer-to-peer lending enables you to borrow money from other individuals or businesses. It can be a good option for businesses struggling to obtain finance from traditional lenders, and interest rates tend to be lower than traditional loans, too – although fees often apply.

Bear in mind that you don’t have the same protection as you would with a traditional lender should you default on the loan.  

Long-term business finance options

Long-term finance typically refers to loans with a term of five to 25 years. 

13. Secured business loans

Secured business loans enable you to borrow larger amounts of cash over the long term. In return, you must secure your borrowing against an asset, such as commercial property or a vehicle. Should you fail to repay your loan on time, the lender has the right to seize this asset and sell it to recover what’s owed.

While this increases the risk for the borrower, it lowers the lender’s risk and means that interest rates tend to be more favourable compared to unsecured loans. You may also find it easier to qualify for a secured loan if you have bad credit. 

14. Angel investment

An angel investor is a wealthy individual who invests their own money into early-stage or growing businesses, usually in exchange for equity. Angel investors are typically experienced entrepreneurs or professionals who want to back promising businesses. Many also provide mentoring and industry contacts, not just money.

15. Venture capital funding

A venture capitalist (VC) is a professional investor (or firm) that provides funding to businesses with high growth potential, usually in exchange for equity. 

Unlike angel investors, VCs manage money from multiple sources, such as pension funds or corporations, so they invest on behalf of others. This means they can invest much larger sums, but you usually need to give up a larger stake in your business in return. VCs can be very hands-on, too, which means they want a say in your company’s management. 

16. Private equity funding

Private equity (PE) funding is better suited to established businesses. A PE firm raises money from institutional investors, such as pension funds and insurance firms, and pools this cash alongside their own money to create a private equity fund they invest into your business. 

The downside is they often expect a large stake (maybe even a majority one) in your business, and they often require detailed documentation, including financial statements and cash flow analysis, before agreeing to invest. 

17. Commercial mortgages

A commercial mortgage is a long-term loan that enables businesses to buy, refinance or develop property for commercial use. You borrow a lump sum against the value of the property being purchased and repay this, plus interest, in monthly instalments. Like other types of secured business loan, if you cannot meet your repayments, the lender can repossess the property. 

18.  Government grants

Unlike a business loan, a grant doesn’t need to be repaid. However, the eligibility criteria can be strict. Government grants are often aimed at supporting start-ups or businesses in specific sectors or regions of the UK. For example, you may be eligible if your business is seeking funding for innovation, research and development, or sustainability projects.

If you successfully obtain a grant, your business receives a lump sum or staged payments, and the money must be spent according to the grant’s rules.

Read more…

• Business loans explained

• Am I eligible for a business loan?

• How to get a business loan?