Sources of Finance: All You Need to KnowFebruary 5, 2015
By Greig Rowand, Corporate Finance Partner
Banks (a traditional source of finance) are slowly regaining their appetite to lend to businesses but in the years following the financial crisis of 2008/ 09 whilst their appetite was constrained, alternative sources of finance sought to fill the gap.
Before business owners start finance raising they need to be clear on several things (or seek advice to obtain clarification):
• How much money is needed? Often underestimated, you’ve got to be prepared for potential funders to probe your assumptions about the amount needed.
• Why is finance needed? Funders like a focussed, well-thought out strategy. Muddled reasons make it easy to say “no thanks”!
• What type of finance is needed and for how long?
• How will the funder get their money back? Banks (or other debt providers) want to know how you are going to afford repayments (capital and interest) and investors won’t want to be involved in your business forever, so you need an exit plan for them.
• It takes time and effort to raise finance, typically, much more than a business owner thinks.
It’s natural to look outside the business for sources of finance but start within the business itself. Timely issue and collection of sales invoices, tight management of stock, requesting better terms from suppliers; often minor improvements in these generate additional cash and save engaging with external funders.
Getting family and friends involved can be fraught with difficulties, but can provide a simple, quick means of obtaining finance. Make sure everyone is clear on the ‘rules’ by which the finance is being provided and repaid, as well as any rights (or not!) that the provision of funding gives to the funder.
Turning to external sources of finance, areas to consider are:
Typically banks would provide an overdraft or a loan to a business. Overdraft is short term funding for working capital purposes that can be repayable on demand. Loans are provided for a longer term, repayable in accordance with an agreed schedule (giving some certainty to the business owner and the bank) and are often secured against specific assets of the business (e.g. property). Recent years have seen banks move away from overdraft funding in favour of asset based lending. That might be changing now and there is also more of an appetite for unsecured bank loans to fund acquisitions, MBOs or shareholder exits, although to get this businesses need robust cash flows, a sound plan and an excellent management team.
Asset based lending
This lets you borrow against the value of your business assets, typically trade debtors and stock, to finance the working capital required. As your assets grow you can increase your funding line appropriately, subject to credit approval. Often used where businesses are growing, ABL can become relatively expensive if that is not the case.
The funder acquires shares in your company in return for providing finance. Investors can range from business angels (mostly interested in early stage businesses) through to private equity firms (mostly interested in revenue generating mature businesses). Typically, there is no agreed timeframe for how long the funding will be provided but most investors seek to exit within 3 – 5 years. Unlike banks and ABLs, investors don’t get to secure their funding against business assets, so seek a higher level of return from their investment to reflect the risk. Therefore, they tend to look for businesses with proven management teams capable of generating high growth levels.
Peer to peer lending
Also called crowd-lending this is facilitated through websites acting as intermediaries, matching businesses (and individuals) seeking to borrow money with individuals (‘peers’) willing to lend money directly without the involvement of a traditional financial institution. There has been substantial growth in this type of lending in recent years and a couple of high street banks have formal referral arrangements with some peer to peer lending sites for businesses seeking funding but which the bank can’t assist.
Like peer to peer lending has grown enormously in the years following the financial crisis and there are now some well-established sites with a track record of providing equity funding from ‘peer’ investors for SME businesses
Sometimes forgotten, but can be a really useful (and cheap) form of finance, typically provided by public sector organisations. Usually no need to repay and no interest charges but the funds must be used for specific purposes and you might have to incur the expenditure before receiving the grant.
Getting finance for your business remains a challenge (albeit things are improving) but don’t wait for funding to ‘land on your lap’. Do the research, get help and make sure the funder and type of funding fits what your business needs. Often it can take time to source, but the right funding at the right time can turn business dreams into reality.