Raising business finance
One seemingly impossible task for many SMEs is that of raising finance. There are over 4 million businesses in the UK. Of these 99.3% are SMEs and 98% of their funding applications fail.
It is noteworthy that SMEs find it hard to raise funds. This is in contrast to their larger cousins.
First of all let us think about what you might want funding for.
You would often need seed capital before you have any money coming into the business. You probably have a good idea and the need is to prove the concept. In this case you might also require less than £50,000.
Because this way of raising finance is difficult, friends and family are the best sources. Grant funding and specialist funds can also be another good source of seed funding.
Start up Capital
You have done your business plan, have also started to recruit your team and are ready to start earning money. You will probably need finance of between £50,000 and £500,000 to get up and running.
At this stage there are three main sources of funding: equity, debt funding and grant funding.
Your business is now up and running and can now grow organically or by acquisition. As a result you need to raise extra funding, over £100,000, to support this growth. Again equity, debt and grant funding can all come in to play. Also debt funding is more often the most likely source. There are more and more specialists who deal with sums of over £1m.
Now let’s review those sources of funding.
Private investors can include family or friends. They can also include Business Angels. Business Angels are high net worth individuals. Business Angels will also either operate alone, typically investing £25,000 to £100,000, or in groups where the equity need is greater. Another issue is that their criteria vary a great deal. You should therefore seek investors who will bring a lot more to your business than just money. This could be in the form of their experience and networks. Typically Business Angels will want to take a non-executive role within your business. They will also be seeking an exit for their investment within 3 to 5 years. Most will be seeking returns of between 5 to 10 times the original.
Regional Venture Capital Funds:
The Government supports a number a small regional venture capital funds. These funds receive hundreds of applications each year for funding. Less than 2% succeed as a consequence.
University incubation centres are often involved with seed funds. Consequently Technology and innovation will often be the focus. As a result, Start-ups will also often be a focus.
Venture Capital Funds:
Traditional venture capital funds are unlikely to invest below £2m. Therefore these tend to be of little interest to the SME sector.
You may be able to obtain debt funding via your bank. You will need to provide security. These will probably be in the form of; Directors Guarantees, Debenture and possibly a Personal Guarantee. Agreement fees will typically be 1.5% with the premium over base in the range of 2.5% to 5%.
Hire purchase, finance lease and contract hire are examples of asset finance.
A finance company or bank buys your debtors and pays you up to 85% of the invoice value. Once your customer pays the invoice, the finance company pays the balance to you. You can do the credit control and cash collection directly. This can also be out-sourced to the finance company or bank. The finance company will charge a monthly fee, typically in the range of 1% to 1.5% of the average monthly invoice value. There will also be a premium over base charged. The premium will normally be in the range of 2% to 3.5%.
There are a wide range of sources of grants. Consequently the application process can be lengthy and time consuming. They will also require you to meet various criteria. These may be:
- location (development areas);
- purpose (technology, training, etc);
- sector (innovation, environment, etc)
- personal (unemployment, etc).
These grant funds vary and can depend on funding availability. They are also often over-subscribed very quickly.
What are my chances of raising finance?
You will need to present a business plan. This applies whether you are seeking to raise equity or debt funding. You will therefore need to clearly describe your plan. Broadly speaking this is what happens to proposals:
- 60% are rejected immediately
- 25% are rejected after a face to face meeting
- 10% are rejected after further evaluation
- 3% fail at the negotiation stage
- 2% succeed in raising the equity or debt funding
What are the main reasons for rejection?
- Poor presentation;
- Financial forecasts are poor with weak assumptions;
- Weak cashflow;
- No track record for the team;
- Lack of commitment from the team;
- No clear exit route.
What are the benefits of Equity funding?
- The funding will be medium to long term with no interest costs or repayment schedules;
- Shareholders may agree to dividends;
- Equity investors should bring experience and networks as well as funds;
- Bank lenders will require equity investment before agreeing to advance debt.
What are the drawbacks with equity funding?
- Early stage investors will be seeking annual returns of up to 40% to cover their risk. This is therefore an expensive source of funding in the medium to long term. You can expect a lower annual return if your business is in its later stages.
- It can often be hard to find right investor. As a result it can typically take 6 to 12 months before you receive the cash. The bank lending process can also be a lot shorter.
- Personal chemistry is always difficult to assess during the early meetings.
- Shareholding dilution with other views on valuation.
What needs to be in a proposal for raising finance?
The business plan will vary depending on whether you are seeking equity or debt funding. As a result, the plan should be concise and should have the following structure:
- Executive summary
- History of the business
- Market opportunity
- Product offering and product development
- Manufacturing or sourcing strategy
- Competition and competitive advantages
- Routes to market
- Risks and threats
- Management team and organizational resources
- Financial assumptions
- Financial plan
- Sensitivity analysis
- Exit route for equity investors
Your business plan MUST NOT:
- Over-sell the business opportunity
- Forecast over optimistic sales. Consequently forecasts should always be conservative and not based on straight line projections
- Be too complex; so don’t use too much jargon
- Discount the effects of competition
To conform to requirements for raising finance you have to identify them, understand them and then meet them.
Finally if you would like to talk to one of our experts about any aspect of raising finance, please email or call and we will be able to put you in touch with the right person.