By Mary Erb, Heatons LLP
At some point, most businesses - whatever their size - will need extra finance.
The reasons for raising funds vary enormously but typically they include: to buy new machinery or a new plant; to overcome a cashflow problem; to replace cars; to mount a management buy-out; to relocate the business; to acquire another business or finance a new development.
Whether you need £5k, £500k or £50m, one simple rule applies: make sure that the source of your business finance and the method of repayment are the most appropriate for your requirements. You could, for instance, discover that a loan is preferable to an overdraft or, indeed, that your bank isn't necessarily the best place to go for the sort of business funding you need. This is frequently called the 'matching principle'.
Just as there are various reasons you might need business finance, there are also a variety of people and institutions that lend it. Sources can include private investors, friends or relatives, although most business funding is provided by the finance industry.
There are no hard and fast rules that say if you need X you should get your business finance from Y. Instead, a combination of how much you need, what you need it for and how long you need it should be assessed before you embark upon any one route.
How you use the funds will also dictate which source you approach in the first instance. Ideally, your first port of call for advice should be your accountant, who will guide you to the most suitable source by applying his or her version of the 'matching principle'.
Structured finance
Most banks have specialised managers who will provide business finance to support deals such as management buy-outs, management buy-ins, acquisitions and mergers, often in tandem with venture capitalists. If you're contemplating a major deal like this, always seek advice from your solicitor.
Mezzanine finance
A halfway house between equity capital, where finance is invested in return for ownership of a share of the company and therefore a proportion of the profit, and debt finance, where investment is repaid with interest. The finance is lent as debt capital, but the lender has the right to convert it to equity capital is not paid back in time.
Mezzanine finance is generally provided relatively quickly with scant due diligence. However, this comes at a price, as interest rates are usually higher.
Overdrafts
A facility arranged with your bank whereby your current account can go into a deficit position within agreed limits for an agreed period of time. This is probably the best known source of business finance for day-to-day working capital.
The interest rate will normally vary in line with the Bank of England's base rate.
Standard-term loan
An arrangement whereby your bank agrees to provide an agreed sum with a fixed repayment period and interest rate. The funds become available at once but you must stick religiously to the agreed terms of your loan.
Fixed-rate loan
Whereas the interest on a variable-term loan can vary with changes in the bank rate, a fixed-term loan will guarantee that you know exactly what your future repayments will be over the whole period.
Leasing
This is a method of getting the use of fixed assets like cars, plants, machinery or buildings, without owning them. Instead, you contract to pay for the use of them at a fixed rate over a fixed period.
Invoice discounting
This is an increasingly popular method of raising business funds.
The monies are lent and secured against invoices raised. The result is a flexible and adaptable form of raising capital to finance business development.
Invoice discounting is designed mainly to provide working capital on an ongoing basis, although increasingly it is used to raise a lump sum at the outset.
Venture capital
This is a term used for finance introduced into a business at the risk of the investor. There are always strings attached, however, as venture capitalists look for some degree of control and very high returns in exchange for taking big risks.
Raising venture capital is a specialist job for specialist financiers. Ask your solicitor, accountant or bank for information.
Asset finance
A highly specialised form of raising funds secured against assets like installed machinery, intellectual property, future royalties or contracted future rental income. If you default on payments then the lender has the right to take ownership of the asset(s) used as security.
These are the key types of business finance available. Now let's look at who provides what.
Banks
Banks are the most obvious places to get finance. If you already have a good relationship with your bank manager, ask his or her advice in the first instance.
Banks invariably take into account your trading history and want to see well presented business plans, audited accounts and management accounts. They will almost certainly demand some form of security against your assets.
Invoice discounters (or factors)
Will advance funds against the value of your approved, raised invoices. Again, your accountant or bank manager will be able to make introductions.
Venture capitalists
Venture capitalists, who are also known as institutional investors, accept higher risks but expect higher returns. They only consider putting capital into a business that can demonstrate serious growth potential.
In return for capital a VC will want an equity stake in the business, a seat on the board or involvement in the day-to-day running of the business.
VCs, as they are commonly abbreviated, tend to work closely with banks. How they share investment depends on the level of risk involved.
Private investors
Usually called 'business angels', private investors tend to want to invest finance in a field they have expertise in. For this reason, they will bring know-how as well as finance.
Local business organisations, or your accountant or lawyer, can put you in touch with business angels.
Local authorities and grant-providing bodies
Local-authority schemes vary from region to region and your local Business Link will be able to advise you. A vast number of grants are available, the main source of these being the Department for Business, Enterprise and Regulatory Reform.
The stock market
Businesses seeking substantial capital can go raise business finance publicly through flotation on AIM, OFEX or the Stock Market.
This involves selling off a proportion of your stake in the business. It isn't really worthwhile considering floating unless you want to raise a substantial sum.
Whichever source you opt for, there will always be certain constraints.
For instance, would you be prepared to sacrifice total control of your business if an equity house became involved? And would you be comfortable with putting up collateral or security if your bank made it a condition of the loan?
Take professional advice and heed it.
Mary Erb advises business in all sectors on deals of all sizes. Recent deal values have ranged from £1m to £320m. She can be contacted on 07712 899313.
