Alternative funding for SMEs |
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| Finance | |
| Written by Michael Weaver - Chief Executive of investment agency Beer & Partners | |
| Wednesday, 20 May 2009 | |
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When bank investment dries up look out for alternative options for business funding in the downturn. Securing funding is critical to the survival of businesses. The primary reason for business failure is poor cash flow resulting from working capital shortfalls, not a lack of profit, and funding is often crucial to ensuring liquidity. Businesses have traditionally looked to banks to secure investment with the boom years being largely ‘debt financed’. For larger companies, debt was perceived as the way to maximise returns to a small group of investors, while smaller or newer companies favoured this approach because it ensured that the lion’s share of their business remained in their hands. However, with the onset of the financial crisis, banks are withdrawing established credit lines and businesses are finding it increasingly difficult to access funds through the banking channel. As a result, businesses have been left short on working capital and the finance required for continued growth. Consequently, they now face the challenge of seeking alternative ways to gain cash in a turbulent landscape.There are different options available depending on the stage a business is at and the type of funding it requires. The first £100,000 of funding for a business is usually regarded as the friends and family round and securing this investment demonstrates the commitment of the entrepreneur, whilst at the other end of the spectrum the venture capital houses are a potential option for those businesses seeking funds in excess of £5 million. However, for the companies who have worked through the initial start-up phase yet do not require investment in excess of £5 million, the reduction of bank credit has had a heavy impact. These companies must now look at alternative means of funding in order to plug the investment gap. Debt factoring and invoice discounting are strong options for companies requiring short term funding between customer payments to increase cash flow. These methods can significantly improve a business’s cash flow by securing funds against an invoice as soon as it is raised. This will enable companies to access money as early as possible in the invoicing process to provide immediate working capital. For those seeking long term funding, the government’s Enterprise Finance Guarantee (EFG) scheme goes some way to fill this gap, as it is specifically designed to help businesses struggling to secure investment. The EFG provides loans up to £1 million for businesses with a turnover of up to £25 million. However, like its predecessor the Small Firms Loan Guarantee, these secured loans can be difficult to access as only a few banking business managers being aware of the terms or availability. Furthermore since the government only secures 75% of the loan and banks take on the full risk, this type of loan is difficult to secure. Consequently, relatively few businesses stand to benefit from this scheme. For companies requiring between £100,000 and £3 million, angel investment - where an individual provides capital in return for a stake in the company - is rapidly proving to be the most viable option. The growing popularity of this type of investment is evidenced by the British Business Angel Association (BBAA), who found that business angels' share of private sector investments in early-stage ventures rose from 16 per cent in 2000 to 41 per cent in 2007. Unlike many other forms of funding, angel investment extends beyond financial commitment to include hands-on involvement from the investor in a start-up or early stage business. According to a survey conducted by Newcastle Business School , 70% of angel investors have previously founded and owned a small business so are well-positioned to add considerable value. In addition, 40% of investors consider the investment of their general management expertise and experience equally as important as their money. Despite this, investors usually prefer meeting with the investee on a regular basis rather than becoming involved as part of a management team or Board. This allows companies to maintain control of their business whilst benefitting from the investor’s funding and experience. As the possibility of gaining funding from banks decreases, angel investment is increasingly seen as the strongest alternative. In order for companies to secure this type of funding, they must look to prepare themselves. A realistic assessment of the level of investment required is a crucial first step to ensure that the funding received is sufficient to see the business through its next stage of growth. Companies must also ensure that sensible evaluations, coherent business plans and strong management teams are in place in order to seize the opportunity and capitalise on the experience that angel investment presents. Those that get it right can receive significant rewards and be set up for future success.
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