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Bank Loan Or Self-Funding For Your Small Business?

In a report released last week, FreeAgent, a web accounting software package, revealed that an increasing number of start-up businesses are seeking alternative funding methods. Many microbusinesses are opting for self-funding rather than taking out small business loans. It is a revealing analysis of how new businesses, especially those set up in the wake of the 2008 financial crisis, are looking outside the box.

Bank LoanThe Findings

44% of those questioned said that they did not need any capital to set up in business. Many of these new businesses have been self-employed app developers, web designers, writers, artists, accountants, data entry administrators requiring only a computer and some basic software.

A similar number, some 43% of those questioned, said they had used their personal savings and cashed in other investments. But it is the figures for bank loans that showed the most startling changes. While 4% borrowed money from family or friends, 2% said they funded their business with credit cards; just 1% said they had applied to banks for business start-up loans.

The Benefits and Drawbacks of Self-Funding

The majority of new businesses do not need a lot of investment. It is possible with a little bit of life savings, depending on the nature of the business you are setting up. The main benefit is that there is no loan to pay back. Loans mean interest and often a pre-set agreed period to pay it back. This will be a significant cost to you just as you are getting started and you may need to use your personal savings to pay it off anyway. Financially, you will just be worse off.

In their favour, bank loans offer flexibility and peace of mind. Banks often offer a business package rather than just a loan. Depending on which bank, they may offer tax advice or the services of a free financial advisor. This is a major perk, one of the reasons that some people still prefer to take out a bank loan even when they already have the capital.

The Questions You Need to Ask Yourself

Before you decide whether to take out a bank loan or self-fund, you need to ask yourself some key questions about the nature of your new business.

Do I Really Need to Spend a Lot of Money?

For the majority of new microbusinesses, the answer will be “no”, especially for those whose businesses operate in the digital marketplace. Business consultancy, writing, web design, app design – you need very little in the way of investments, perhaps a few hundred pounds at most.

Could I Afford to Pay This Back At All?

There is no place for blind optimism when starting a business. You have to demonstrate that you have the capacity, not just to pay it back on time, but to pay it back at all. The bank will not necessarily want to see a comprehensive business plan, but they want to see that you can make money doing this – enough to live on and enough to cover your debts to them.

Do I Have Other Ways of Funding This?

A bank loan should never be the only form of funding to consider. Credit card cash advances are actually cheaper, and some offer long repayment periods of interest free with only a nominal admin fee (typically around 3-4%). Savings are another option, especially at a time when the interest rate is so low.

Maybe Crowdfunding is the Way To Go?

This modern method has had some success for some businesses. Rather like charitable donations, you ask people to “sponsor” you to set up your business and use that money as investment. They can give as little as £1. Funding from enough people can lead to a large amount of cash up front with no need to pay it back. However, when raising capital this way, you should offer your investors perks for doing so.