Appearing on television show Dragons’ Den probably isn’t the best bet for a company in search of extra funding. Geoff Wright takes you through the more likely alternatives.
Everyone is treading carefully around the R-word right now and the line from those holding the purse strings in the South West is that they remain very much open for business.
Recession or no recession, it is still a good time for companies to look carefully at how their finances are structured. Whatever the economic climate, money will always be needed for growth, acquisition and, in some cases, survival. And the squeeze on credit is concentrating the minds of the business community and its financiers.
The basics may not alter, but the consensus is that anything from rescheduling to fine tuning is probably called for to get your funding right in more straitened times.
Is the company borrowing over a long enough term? Are the repayment terms flexible enough? Would giving away some equity make sense? And is the company making enough use of its assets?
These are all questions that are worth asking and the financial products are out there to cover most scenarios. So it’s really a question of being aware of the alternatives that are available.
To start with, there is asset finance, in which a company borrows against stock, equipment or property it owns. This can work like an overdraft and change as the assets vary, or it can be in the form of long-term debt based on the value of fixed assets. Invariably, it is a combination of the two.
This is suitable, typically though not exclusively, for those operating in the manufacturing industry – particularly engineering companies that are holding costly equipment that has a reasonable life expectancy.
Another option is business angels. These are private investors who take equity in a privately owned start-up or develop companies with strong growth prospects. They are usually experienced business people looking to use their money and skills to support promising businesses and make a capital gain.
Alternatively, venture capital may be available, which involves outside investors paying cash for shares in a new or growth business and will probably involve a fund backed by individuals, banks and other financial institutions.
Private equity (PE) is another route, where the managers of a PE fund a stake in a business for cash. It is usually an option for businesses of a certain size and profitablity, often where a management buyout (MBO) or buy-in (MBI) is in the offing. It is a longer-term commitment – typically up to five years – and is based on a company developing or restructuring to become more profitable.
Mezzanine finance combines the characteristics of debt and equity but its exact nature will depend on the needs of the particular business. Used most frequently for MBOs or expansion, it typically runs over five to seven years in the form of subordinated debt, preference shares or convertibles.
Invoice financing, which uses money owed to a company, is particularly suited to companies that sell to others on credit It allows them to use the debts as security for raising working capital. And it usually removes the need for personal securities or external funding.
Integrated finance is also a funding package involving debt and equity. It can be structured to leave the management in control with a majority equity stake and can be a tool for family businesses looking for a long-term solution to succession planning.
Another option is trade finance. This provides money to pay suppliers for the purchase of finished goods, normally against firm customer orders or where there is a proven demand for the product. It is seen as an alternative for businesses unable to raise money through traditional banking and factoring facilities. A revolving credit facility is a combination of overdraft and long-term loan that allows a borrower to draw down and repay amounts for short periods throughout the life of the facility. Money repaid can, if necessary, be borrowed again. The Small Firm Loan Guarantee Scheme is for smaller businesses that lack security but have a viable business plan. It is a joint venture between the Department of Trade & Industry (DTI) and the approved lenders. Changes in March 2008 mean maximum loans have risen to £250,000 for companies with a trading record of more than five years. The DTI provides 75 per cent of the security to the bank and borrowers are not asked for personal guarantees.
Vendor deferral is often asked for when a business changes hands in a succession deal or MBO. It involves the owner agreeing help to cover the costs of the new team by deferring some of what is owed for a specified time.
Clive Hetherington, director of large corporate for Lloyds TSB in the South West, says structuring the balance sheet is always extremely important but even more so at the moment. “We are not yet in a recession, but a proper structure of the balance sheet is essential. Banks asked for funding are looking carefully at the gearing of businesses,” he says.
“It is essential to get it right if you need working capital. There are ways of ensuring you have the commitment of your funder through the economic cycle.
“Make sure you have term debt over five, ten or 15 years and ensure long-term assets are funded by long-term facilities. If you need new trucks, for instance, asset finance could be the option.”
Hetherington also recommends that companies ensure they have the right amount of equity in their makeup. “Along with long-term arrangements, this is even more important during times like these,” he says. “If a business does not need to take a large lump of cash, a revolving credit facility may be appropriate.
“People are saying it may be time to batten down the hatches and postpone capital expenditure, and there is logic to that, but no business should set out to tread water because there is a danger they will ends up going backwards.”
Matt Hatcher, head of structured debt solutions for the Royal Bank of Scotland in the South West, specialises in the market involving businesses with turnover between £1m and £25m that are looking to grow, acquire competitors or complete an MBO or MBI.
He also sees the advantages of asset-based lending and urges businesses to take advantage if they have property on a freehold or a long lease – or plant and machinery that still has a useful life.
“Owner-managers may have commercial property owned through a pension plan that can be leased back to the business to raise money against the property to inject into the business,” he says. “Invoice discounting, which is light on covenants and based on sales and debt, remains evergreen with the major benefit of maximising cash flow. This is the best tool for many growing businesses and, for smaller businesses, factoring – outsourcing credit control – could be the answer. “
For MBOs and acquisitions, the vendor may leave a deferred consideration – rolling over equity for instance – that is repayable over a set time. It can act as a pension or annuity for the vendor,” he adds.
Hatcher says other sources that could play a part include the Small Firms Loan Guarantee scheme and business angels. But whatever financing packages are put in place to help expansion, he warns that businesses must always be aware of the implications of growth on cash flow.
“Despite the well-publicised problems affecting the economy, our marketplace is still active,” he says. “We are still open for business and the business is there.”
Philip Tellwright, managing director of South West Angel and Investor Network (Swain) – the-fastest growing and most active regional player in the UK business angel market – says borrowing money is the logical place for most smaller companies to start. “When raising money, looking to borrow it is the right thing to do in many respects. But our method is used most frequently for development and early start situations when backing could be tight because the potential benefits are not clear for others in finance.”
He says angel money, which on average is made in return for an 18.5 per cent stake, can be useful because it allies money with expertise. “I feel an awful lot like Simon Cowell sometimes – listening to a group and thinking that despite everything they may just have something here and may just make it work,” he says. “An angel invests anticipating a return and the only way it works is with an exit strategy. It’s about finding the right chemistry between investor and entrepeneur. No one can just pick winners and a business angel should really have at least half a dozen investments.
“To be attractive to an angel, the business will be in a market that is growing, have a product that sets itself apart and a management team that can deliver.”