Understanding the True Cost of Business Funding

When comparing funding offers, it's easy to get confused by different pricing structures. One lender talks about APR, another quotes a factor rate, a third mentions a flat fee. How do you work out which offer actually costs less?

This guide explains the most common pricing models in plain English, so you can make informed comparisons.

What is a Factor Rate?

Factor rates are commonly used for merchant cash advances and some short-term business funding. Instead of an annual interest rate, the cost is expressed as a simple multiplier — typically between 1.1 and 1.5.

Here's how it works: if you borrow £10,000 with a factor rate of 1.3, you'll repay a total of £13,000 (£10,000 × 1.3). The cost of borrowing is £3,000, and this amount is fixed from day one — it doesn't change regardless of how quickly or slowly you repay.

• Advantage: total cost is known upfront — no surprises
• Watch out: factor rates are harder to compare directly with APR, so always calculate the total repayment amount

What is APR?

APR (Annual Percentage Rate) is the standard way of expressing the cost of borrowing for traditional loans. It includes the interest rate plus any mandatory fees, expressed as an annual percentage. This makes it useful for comparing like-for-like loan products.

However, APR can be misleading when applied to short-term funding. A product designed to be repaid over 6 months will have a much higher APR than one repaid over 5 years — even if the total cost in pounds is lower. APR is most useful when comparing products with similar repayment terms.

• Advantage: standardised, regulated, good for comparing traditional loans
• Watch out: can appear artificially high for short-term products — always check the total repayable too

What Are Flat Fees?

Some funding products charge a simple flat fee — for example, a fixed percentage of the amount borrowed. A 10% flat fee on a £20,000 advance means you pay £2,000 in total charges. Like factor rates, the cost is clear from the start.

Be aware that some products may also include arrangement fees, administration charges, or early repayment fees on top of the stated rate. Always ask for the total amount repayable, including all fees.

How to Compare Costs Fairly

Because different products use different pricing models, the most reliable way to compare them is to focus on the total cost of borrowing — the actual amount in pounds you'll pay back above what you received.

• Ask every funder: “What is the total amount I will repay, including all fees?”
• Calculate the cost per pound borrowed: subtract the advance amount from the total repayable, then divide by the advance
• Factor in the repayment period: paying £3,000 in charges over 6 months is very different from paying £3,000 over 3 years
• Check for hidden fees: arrangement fees, early repayment charges, late payment penalties

Why Cheapest Isn't Always Best

Cost matters, but it isn't the only factor. A funding product that's slightly more expensive but arrives in 24 hours could be worth more to your business than a cheaper option that takes 6 weeks to process.

Consider these alongside cost:

• Speed: how quickly can you access the funds?
• Flexibility: are repayments fixed or do they adjust with your revenue?
• Eligibility: the cheapest product is worthless if you can't get approved
• Security requirements: does it require personal guarantees or business assets as collateral?
• Opportunity cost: what's the cost of not having the funding when you need it?

Questions to Ask Before Accepting an Offer

Before signing anything, make sure you can answer these questions:

• What is the total amount I will repay, including all fees and charges?
• Are there any arrangement, administration, or early repayment fees?
• What happens if I miss a repayment or my revenue drops significantly?
• Is there a personal guarantee, and what does that mean for me?
• Is the lender FCA-regulated?
• Can I repay early, and is there a penalty for doing so?

Any funder should be willing to answer these questions clearly before you commit.