Raising finance is key if business ideas are going to make the transition from being great concepts
to products or services sold in a marketplace. Assuming entrepreneurs have already made use
of their own resources and sought finance from family and friends, the next stage is typically either external sources of debt or equity.
On the debt side, it is the banks that are the obvious source of finance. Unsecured debt in the form of an overdraft may be available, but precisely because it is unsecured and riskier for the bank, such amount as can be obtained will be limited and interest rates are typically higher than for longer term debt. Another key point about an overdraft is that it is designed for the short term – to help manage cash flow over different business cycles. In some months cash may be positive, but in others bills to be paid may exceed cash coming in even though a business is profitable. These are the circumstances that overdrafts are designed for. Some equity investors help pre-revenue businesses with proof of concept and seed funding, but competition for this type of finance is fierce.
Once a business has made sales and is earning revenues, more routes for financing open up. If entrepreneurs need longer term finance to develop a business, then banks can again help. This includes the government backed enterprise finance guarantee ("EFG") where up to £1m can be obtained subject to certain conditions. It is important to remember, however, that longterm debt will need to be repaid with interest, so banks will consider a business’ ability to repay as part of their loan assessment. Often they will look for security to cover their risks e.g. if the lending can be secured on property and/or with personal guarantees from the business owners. There are variations on the theme set out above. For example banks may be more willing to lend debt where this is matched £ for £ with equity from one or more business owners. It is also possible to find mezzanine debt when usual funding is unavailable, but inevitably this is riskier for the body providing the finance, so interest rates rise accordingly.
Where businesses are already generating sales and have money due from debtors, invoice discounting or debt factoring can be available to help ensure businesses stay cash positive. Raising finance can be a challenge, but with appropriate professional advice it can be less daunting.
There are situations where debt finance is not suitable or where businesses otherwise decide to look for equity funding. Equity finance is risk capital. Investors who are willing to put finance into a business understand that their investment may turn out to be worthless, but their intention is that they will earn a return on their investment, either in the form of dividends or capital growth or, ideally, both.
Key to understanding whether your business might attract equity finance is understanding what providers of such finance are looking for. Many business angels and venture capitalists are focussed on the prospect of an exit from the business at some time (say five years) after the initial investment. Varying degrees of support may be offered to the business, with some investors being more “hands on” than others in the management of the businesses they fund. All will assess the quality of existing management running a business and will also look for regular reporting of financial results so they can understand progress made with developing and marketing products or services, and ultimately the return they are likely to enjoy as the business grows.
Adam Stronach: 'Whether a business is trying to convince a bank to advance a loan or is approaching investors for equity, it is important for a business and financial plan to be developed, summarising how the business is going to develop, where its markets are, what factors are going to make it successful and what its financial performance is expected to be".
Raising finance can be a challenge, but with appropriate professional advice it can be less daunting. Every year Harwood Hutton provides advice to many businesses going through these growing pains, helping them to develop future plans and financial forecasts and seeking out bank loans or equity investment.