| There is
an old saying that there is never a shortage of people offering
you money when you don’t need it. It is a vicious circle:
you need to have a sound business to attract money –
but you need money to build a sound business. Breaking that
circle is possible if you can convince people that you are
likely to have such a business.
This guide explores the main types of finance available and
what investors and lenders look for before they advance money.
Types of finance
There are many different types of finance available, depending
on whether you want short or long-term funds and for what
purpose. Raising cash for day-to-day needs (working capital)
is quite different from raising money for a long-term capital
project – say, for buying new machinery or property.
It is a big mistake to confuse the two and financiers will
want to be sure their money is invested in the way you say
it will.
Sources of cash include:
- Credit from suppliers.
- Overdraft.
- Loans.
- Leasing or contract hire.
- Factoring.
- Equity.
- Grants.
- All these balance risk and reward – the greater
the risk, the greater the return required.
Taking credit from suppliers
Credit is, in effect, borrowing from your suppliers. It can
take many forms, varying from industry to industry, but includes
the common practice of suppliers giving you time to pay them.
Payment terms tend to be standard throughout most sectors,
with large or long-standing customers having some advantage
in generally being able to negotiate better terms.
Credit is something that may be convenient in cashflow terms,
but you should not consider any money released as capital.
For example, it is generally not a good idea to use this money
to buy a new car or carry out property improvements. This
is because you have simply negotiated a delayed payment to
your suppliers. Your suppliers will still have to be paid
– as will HM Revenue & Customs for the VAT on the
sales if you are VAT-registered. Hopefully, you will sell
most of the goods before you actually have to pay for them,
so enabling you to use the cash generated from the sales to
pay for the goods.
Overdrafts
Many small businesses use a bank overdraft. Overdrafts are
flexible and are often the best way to cover short-term requirements
for the day-to-day running of a business if, for example,
there’s a delay between selling goods and paying for
them. It’s most likely that your bank account will sometimes
be in credit and sometimes be overdrawn. If your account remains
overdrawn for a period of time, an overdraft is probably not
the best finance option for your business. There may be other
alternatives that can be discussed with your bank.
Loans
Loans are the traditional source of finance for small businesses
and are usually used to finance assets and to meet other longer-term
capital needs. You know how much you have to pay, for how
long. You can, to a certain extent, negotiate the terms and
interest to suit your business.
Loans are usually arranged through a bank. There are also
other sources of loan, and specialist consultants willing
to arrange them. However, unless you have particular experience
of the financial sector yourself, the safest route is to go
through a bank. If your bank turns down your request for a
loan, it may be that it has spotted something you have not,
or simply that you’ve failed to make your case convincingly.
The Small Firms Loan Guarantee Scheme, a Government backed
initiative, may be available to those businesses who don’t
meet the normal lending criteria.
If family and friends lend you money, it is essential to
have a formal agreement on paper so that everyone knows where
they stand.
Leasing
Leasing or contract hire are simple ways to fund the purchase
of capital items like machine tools, cars or computers. Several
types of arrangement are possible, each with their own tax
advantages.
Factoring
Factoring releases cash to boost your business cashflow.
Essentially, factoring advances cash against your outstanding
invoices – up to 90 per cent as soon as you raise an
invoice. When the debt is collected, the factor pays you the
balance, less a small charge.
Factoring simply offers you a way to release cash tied up
in your debts. This is a good option if your business needs
additional working capital.
An alternative to factoring is invoice discounting. The main
difference from factoring is that you collect the money, so
your customers are not always aware that you have borrowed
money against their debt.
Equity
One way to raise extra capital is to sell shares in your
venture to workers, family, friends, the public or professional
investors. In a business, the principals, partners or shareholders
own the business. After tax and interest is paid, all the
profit is theirs. However, if there is no profit, they have
nothing. They also share the risk.
Ideally, the managers of a business should have a substantial
equity stake in it, so that they have a vested interest in
whether it succeeds or fails. It also reassures the other
investors if they are willing to put their own money in.
Other shareholders may include ‘silent partners’
or ‘arms-length’ investment funds. However, these
can be very vigilant, expecting a regular return on their
investment, and quite capable of using their voting rights
when that return is not forthcoming.
Private investors, or business angels as they are commonly
known, also invest money in return for equity. Some want the
kudos of being involved in the business without taking an
active role; others will want a more active role, investing
their expertise as well as their money. It is rare but not
unknown that sometimes this may extend even so far as becoming
an employee. All, however, will all look for a return on their
investment within three to five years.
Venture capitalists are often prepared to give potential
high-fliers significant backing in return for equity. So they
will only invest in businesses with a solid business plan
and, ideally, a good track record. This usually means one
that has traded for three years, and which is turning over
at least £1m.
Grants
There are a variety of grants on offer from Europe, Westminster,
the Scottish Parliament and Welsh Assembly and local authorities.
Exactly what is available varies from area to area, and can
depend on how you organise your business, and when in the
fiscal year you apply.
There are specialist consultants who can advise you, as well
as business advisers at your local Business Link or national
equivalent. However, the best advice is to befriend someone
in the system itself – for example get someone who works
for one of the grant providers to take you under their wing.
They can probably lead you to other grant providers. Once
one public authority is backing you, others feel more comfortable
about doing the same.
Most grant providers look for two things:
- Growth – i.e. the grant will lead to additional
economic activity and provide an opportunity for something
you could not achieve without the grant.
- Viability – i.e. the additional economic activity
is viable and self-sustaining.
There are three issues to consider when chasing grants:
- They are a complex area and you can waste days achieving
nothing.
- It can be expensive in terms of professional fees to meet
some grant requirements.
- You may not be allowed to spend any money on the project
for which you are seeking a grant until you receive it.
Therefore, you could be left in limbo for months.
On the other hand, there are websites that can help you source
grants, and business advisers from Business Links who can help
you raise them.
What all lenders and investors look for
Most types of finance depend on your business having:
- A good track record (if an existing business).
- Good management.
- A good business idea in a properly researched, well thought-out
and well presented business plan.
- Strong financial controls.
- Personal commitment.
- Security.
Note that security, while important, is not as important as
legend suggests. It relates to what happens if things go wrong
– but financiers will only invest in the first place if
they believe things will go right. What you hear from financiers
time and again is: ‘We invest in people’: they are
looking for a strong management team with the skills to succeed.
Track record
A solid, well-established business, with steady sales and
profits, and a good balance sheet, will have little difficulty
in raising appropriate funding. However, most people are not
in that happy position, particularly new businesses.
Good management
If your business has no track record, investors will look
at the person or people running it. In particular, they will
look for:
- Experience.
- Expertise in their particular specialisms.
- A balance of skills.
- The ability to work together.
Business plan Before anything else, your
basic business idea must be sound – without that, nothing
works. However, good business ideas are common. Those that
become successful businesses need a viable business plan.
There is no set format for such a plan but a good one must
have the following:
- A clear purpose.
- Specific objectives that further that purpose.
- A workable strategy to achieve those objectives.
- Evidence of market research.
- Realistic forecasts based on detailed calculations.
- Milestones for the future – so you can see if you
are achieving your goals and can take corrective action
if necessary.
Obviously, investors are looking for a good return but they
are deeply suspicious of miracles. Nothing destroys the credibility
of a business plan faster than over-optimistic forecasts. Caution
is the mark of experience.
Financial controls
Too many potentially good businesses fail because they have
cashflow problems and lack good financial controls. So investors
are wary.
Existing businesses must have systems in place to prevent
this sort of thing. But what can new businesses do to prove
their financial discipline?
- They can show awareness of the issue in the business plan
and in any interviews.
- They can show what systems they will put in place to address
the issue.
- They can get good financial advisers on board from the
start.
An experienced accountant is a big asset from the start and
it is reassuring to investors to have one with a good reputation.
However, actions speak louder than reputation. If you have an
accountant, get them to check the forecasts in your business
plan. They may know of sources of income and expenditure you
have not considered. Have them check your calculations too.
Talk to them about financial controls – what books to
keep, what software to use, the possibility of management accounting
and occasional internal audits. Then tell your investors what
you did.
There are other sources of financial expertise you would
do well to exploit. Your bank has a wealth of experience as
well as money, so don’t be afraid to use it.
Personal commitment
It is often not enough simply to offer security. Investors
will expect you to put your own money into your business.
After all, if you have no confidence in it, why should they
have any? This need not be a large percentage of the total
capital, but you must show that you have something to lose
and are totally committed to the business.
Security
Security is a final fallback position, so the other factors
are more important. However, investors always consider the
worst-case scenario. In the event of failure, they may get
part of their money back from two sources:
- Any remaining assets of the business.
- Your personal assets.
The assets of a failed business rarely amount to much. Employees
and the taxman are paid before lenders, and lenders before shareholders,
who usually get nothing. The resale value of unused stock, plant
and machinery is usually far below book value, which is far
below what you paid for them.
If the business is a limited company, although there are
legal exceptions, the shareholders’ liability is confined
to the value of their shareholding. So, lenders usually ask
for some form of personal guarantee from the person or people
who set up the company. If such a guarantee is given, or if
the business is not a limited company, your personal assets
may be used to pay off business debts.
Always think carefully and take professional advice before
giving such a guarantee. A guarantee may be required by lenders
– again, not so much for its monetary value, which may
be a fraction of the business debts, but as a proof of your
commitment to the business.
The government’s Small Firms Loan Guarantee Scheme,
administered by the banks, is there to assist new or existing
businesses that have a viable business plan but lack the necessary
personal or business assets to secure normal borrowing. In
this case the Government guarantees the lending bank against
default by the borrower.
Approaching investors
Before you approach anyone to lend you money or invest in
you, work out a strategy and stick to it:
- Make sure the type of finance is appropriate for what
you are buying. For example, don’t use an overdraft
to buy a car unless you plan to sell it very soon. Decide
precisely what you want and how much you are prepared to
give up/pay before you meet potential investors –
they will have a good idea of what they want.
- Be prepared to walk away if the deal is not right for
you.
Your best starting-point is to approach those who know you personally.
Ask your own bank first. Then approach people who have been
recommended by friends and colleagues.
If you have no alternative but to start trying at random,
get some independent advice first – talk to an accountant
or your local Business Link. If you are looking for serious
money, for example in the City, you will need a professional
adviser who knows their way around.
When you meet these investors, keep these points in mind:
- Don’t be daunted.
- Remember they need you as much as you need them.
- Listen to what they say – they may have good advice.
- Don’t try to oversell your idea – they have
heard hype before.
- Don’t undersell yourself either – don’t
grab any deal you’re offered. If your idea is a good
one, others may offer you a better deal.
It may take time – a lot of time – and lots
of preparation to raise finance, but if you have a sound
business idea, sooner or later you should find that someone
will be willing to back you.
British Business Angels Association
Liz Carrington
5th Floor
52-54 Southwark Street
London SE1 1UN
T: 0207 089 2305
email: liz@bbaa.org.uk
W: www.bbaa.org.uk
British Venture Capital Association
3 Clements Inn
London
WC2A 2AZ
T: 020 7025 2950
F: 0207 025 2951
W: www.bvca.co.uk
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