STRATEGIC FUNDING – Where to find the capital your business needs – Part I

Funding growing businesses is one of the major challenges any entrepreneur and business owner will face, and while there is an increasingly vast array of options available, figuring out how to access these funds can be a very time consuming, frustrating experience, even for the most seasoned business owner.

Whether you need working capital to support your growth, raise funds for a push into a new market, introduce a new product range or even have a requirement to raise funds for a new business venture, figuring out what you need to do and where to go can be difficult. With the advantage of “doing this for a living”, this report summarizes the process and points you in the right direction in terms of funding providers and where to go to get the independent specialist advice you are likely to need.

Highlights

• Which type of funding will suit your needs?
• Sources of funding (including advantages and disadvantages of each one).
• Where to get independent specialist advice on your funding options and presenting your case for the best chance of success.

Introduction
Whether you need $1,000 or $10 million, there are only two kinds of finance: equity, whereby you are raising money in exchange for for ownership of the company, and debt which is borrowed money. The first step in raising capital is to decide between equity or debt. In the SME world, the choice usually depends on the preference of the business owner and stage of the company.

If you want to maintain total control, you are typically going to prefer a debt driven funding route: however if you are less worried about control, bringing in equity funds can often mean you grow faster. This can be a good route, particularly where you have a very clear exit in mind and this exit lines up with other equity providers.

In most SMEs the entrepreneur or business owner is the person who looks for funding the business needs. When raising debt finance, our experience is that banks are still the most frequent form of funding used, but increasingly owners are hearing about and starting to use new forms of finance outside of traditional banks. This so called alternative funding market is growing rapidly, and has more than doubled in size year on year from £267 million in 2012 to £666 million in 2013 to £1.74 billion in 2014, according to the “UK Alternative Finance Industry Report”.¹

Equity financing can come from individuals, so called angel investors, and traditional venture capital firms. Depending on your ambitions, there is also the option to combine both debt and equity in a funding mix to provide the capital base for long term growth and the working capital to support working capital requirements in the business.

While there is copious advice for those businesses seeking to raise funds for start-ups, this report focuses particularly on the challenges facing mid sized companies who are past start up and need funds to continue to grow (those with annual revenues between £2M and £50M, or employing staff between 10 and 250 employees).

Sources of funding for mid-sized business

Bank Operating Line of Credit

For many businesses the bank operating line of credit remains the traditional form of funding, with relationships formed over many years.

Although lines of credit can be quick to set up, the biggest drawback is that they can be called in by the bank on demand. So when things aren’t going well and you need the facility, that’s just the time when the bank might demand repayment, particularly if you haven’t built a strong relationship with the bank, so they understand what’s going on in your business.

Loans

A bank term loan will have a maturity date and require principal repayments over a fixed period of time (typically 2 – 5 years). As long as you payback the money per the terms of the loan, the advantage is that the bank can’t demand repayment, although typically the business and usually the owner will need to offer strong security for the loan, usually secured on the assets of the business and often the owners personal assets, by way of a personal guarantee.

As with operating lines of credit, the irony is that the more profitable and cash generative your business is, the less likely the bank’s requirements for security.

The principle is straightforward: if your business has performed well over the years and the bank has confidence that performance will be continued, then the easier it is to borrow money against security, or in some cases simply the cash flows of the business.

Invoice Discounting (Factoring)

Invoice discounting, also referred to as factoring, has grown in popularity in recent years. Banks and other specialist invoice discounting firms lend money which is secured by your accounts receivable, so if the company fails, the bank or specialist firm has more security than in the case of a conventional credit line.

With invoice discounting, you effectively sell your outstanding business invoices to a third party. You get the cash flow benefit by receiving a percentage of the money immediately (usually around 80%) and the rest when the money is collected.

Invoice financing can be really beneficial for growing businesses and can help you to bridge the gap between the delivery of goods or services and the payment from your customer.

Asset Financing

An important consideration of financing, is the overall mix of funding a company uses. Asset financing can be used for funding fixed assets such as plant and machinery, equipment, computers and vehicles. All the main banks have asset financing arms and there are also many specialist companies in this space. The bank or finance company takes security of the asset as their protection. This form of financing has the benefit that it is pretty easy to arrange, assuming the assets you are buying are standard.

There’s also another type of financing: the alternative financing.  Come back for part II of this article, where we will discuss these alternative financing sources.

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1 ‘Understanding Alternative Finance: The UK Alternative Industry Report 2014’, Baeck, Peter; Collins, Liam; Zhang, Bryan, Nesta & The University of Cambridge, November 2014