Raising
Small Business Finance
Introduction - it is becoming increasingly
difficult for small firms to access small business finance credit from high
street lenders. Less firms are successfully
obtaining an increasingly larger amount of business finance and credit , in
order to survive and grow. Most business owners have to
provide personal security to obtain term loans or overdraft facilities.
With this deteriorating economic environment in mind, the following are the main
ways companies can adopt in raising business finance:-
Bank Loans - nine out
of ten small business firms use banks to raise business finance. Banks are looking for
the security of a company asset, so they have relative certainty that they will
receive their money back at the end of the period. Banks will charge interest
rate that reflects the conditions of the current market and also the level of
risk attached to the proposal. Banks also look at the range of factors related
to the borrower themselves, when evaluating loan requests. These include the
character of individual (in terms of their credit history and whether or not
they have a history with the bank itself). Banks also look at the capacity in
other words the borrower's ability to repay a small business bank loan, based on
a credible business plan.
They also look of the collateral of a borrower to see if the asset proposed is
worth in excess of the loan. Banks also look at the capital to see whether or
not the assets exceed the debts.
Overdraft - the main type of short-term bank funding is
overdraft which is usually secured based on the assets of the company. An
overdraft facility is commonly used when companies have volatile cash flows in and
out of business. For instance, the need to purchase raw materials for production. Other types of bank lending
banks are also a good starting point of the debt financing because they can
provide less of credit for businesses who require them to facilitate dealings
with overseas suppliers. Some suppliers may need paying settlements in their own
currency which can easily arranged with a bank.
Term Loans - if a business needs to invest in some new
machinery for some kind of large long-term manufacturing process such as
printing or manufacturing, it normally expects profits to be returned over a
number of years. Raising business finance required for these large capital investments also
needs to be financed over a long period time. Term loans provide a long-term
commitment for company. The interest on time loans can either be fixed or
variable. Fixed rate loans at present about 50% of loans across the UK. The
main advantage with term loans is that banks cannot pull rug out from under
the owners of businesses feet back its unlike overdrafts. About one third of
term loans in the UK are over 10 years and about 25% less than three years.
Terms loans are marketed by financial institutions using the following
commonly used product groups:-
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Business Loans - Commercial business loans
are designed to support the start-up firms and all are subject to the credit
status of the business and its owner. They are very similar to the structure of
personal term loans in that they have pre-agreed length of time, fixed or
variable interest rates as well as potential exit and early repayment penalty
clauses. The main difference is that high street banks will usually offer these
types of loans via a small business adviser whose job it is to oversee the book
of business in that local branch area. Cross selling and up selling of other
products will be one of the advisers primary measures of success and many small
businesses will tend to obtain their loan from the bank that already provides
their bank account. The credit crunch has made it more difficult to shop around
and compare business loan from lenders. The number of loans on the market and
stricter lending criteria is forcing more and more small businesses to opt for a
loan from their own branch.
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Commercial Property Mortgages - The credit
crunch has made obtaining commercial lending very difficult indeed, as
commercial property prices in the UK have plummeted. Refinancing also
includes the remortgaging of commercial property. In the past, many business
owners have been into this option, during a record period of property price
growth and easily obtained mortgage credit. However, the prospect of negative
equity (where a building or asset has reduced in value to that of less than the
loan secured against it), is now a very real issue in the current business
climate.
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Secured Loans - a secured loan is usually
secured over an asset of a company such as buildings or land. Providers of
capital who of secured loans want to ensure their order of repayment is high.
Charges secured over assets are usually defined as fixed charges or floating
charges. Fixed charges are highly specific such as land, property and buildings.
Floating charges are attached to "shifting fund assets” such as stock. If a
company defaults on its loan repayments, it may cause the floating charge to
“crystallise" and become a fixed charge.
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Unsecured Loans - During the last
decade interest rates and inflation remained relatively low and consumers have
enjoyed relative cheap finance. A huge range of unsecured personal loans have
been marketed and sold to millions of people across the UK. The interest rate of
an unsecured loan depends largely upon the individual's credit score rating. An
impaired credit history (linked to unpaid bills, county court judgements, and
all other socio-economic data), may dictate and individuals ability to achieve a
cheaper unsecured loan. Individuals that continue to apply for a variety of
quotes from loan companies will have a larger credit file and a 'footprint'
which other lenders can see. It may appear to lenders that the potential
borrower is shopping around the best deal, if there is lots of history footprint
on the file. Unsecured loans have similar characteristics; Firstly, they are
typically short-term and are expected to be repaid within a few years. Secondly,
they are charged on a monthly basis which means that the borrower can budget for
sensible repayments. Thirdly, there's no need to put up any security for the
loan i.e. it is unsecured. The marketing of these loans has become lifestyle
specific. Advertisements target interest groups such as the young couple needing
a conservatory or home extension, or the wedding reception. The most popular
form of unsecured loan for buying a car, which accounts for about half of the
loans issued in the UK. Now the credit crunch is biting, lending criteria
has tightened and repayment of old unsecured loans is becoming a higher
proportion of ordinary families disposable income.
Credit Unions - credit unions are a useful alternative to
mainstream banks and are formed by groups as individuals or businesspeople. They
provide a cheaper and more convenient method of banking. The members of the
union have to save a regular basis in order to qualify for a loan from the
credit union. There is no interest rate which is set. A dividend is normally
payable to all members of the union, generated from any surpluses and is
approximately 5% per year. This represents a good return compared to high
street business interest rates.
Local Exchange Trading System (LETS) - since the mid
1990's, there have been hundreds of UK based local exchange trading system's
(LETS) in operation. This business model provides a form of old fashioned
bartering, where skilled members provide small business services to other members (such as
gardening, plastering, plumbing and so on). The price of a job is based on a
notional currency has been adopted by the members of the system. Although no
actual money changes hands, the provider of the service receives a 'credit onto
his account'. This person in credit can then use this to buy other services from
other members of the system. In effect it's a simple way for skilled tradesmen to
receive services they would otherwise would have had to pay for. One
of the critical areas of success to ensure the system works is a local and
innovative community organiser, who can maintain a comprehensive directory of
local members and their specialist services.
Asset Backed Leasing - businesses that use physical assets
such as cars, excrement and computers can lease equipment, as opposed to
purchasing the same equipment outright. This is usually done using some kind of
hire purchase agreement or 'finance lease'. This finance vehicle has the
business benefit of reducing the cash out flow for a new business or a business
seeking to grow. This means they do not to obtain capital loans and term
finance. Operating leases are usually taken out on the basis that the company
will use the assets for less than the expected life of the economic asset. The
lessor takes a calculated gamble that the asset will not become obsolete before
the lease term ends, providing a residual value. They take into consideration
the responsibility / cost of insuring and maintaining the equipment should go
wrong. The business user simply pays a regular hire charge for the equipment/
asset. Hire purchase agreements are similar in principle, apart from
the fact that the business will own the assets at the end of the agreed term
after completing all of the agreed payments over the period.
Alternatively, a company could adopt an 'operating lease' model; which is
more expensive than a finance lease. This is because the lessee pays
regular amounts equivalent to the economic life of the asset (minus profit
margin) and bears the cost of maintenance and insurance themselves. Most leases
have some kind of extension clause built into the lease to assist the leasing
organisation to resell an additional lease at the end of the term.
Trade Credit - once a small business has established
itself with its suppliers, the suppliers may provide some form of trade credit
to the business. This usually means that the business has between one week and
three months before they have to pay for the goods or material or services,
they've purchased from the supplier. This has the obvious advantage of providing
critical breathing space and cash inflow, which the business can exploit
elsewhere. Most trade credit provides incentives and 'discounts for cash
settlement in full'. It is only natural that the supplier does not want to
extend credit facilities any more than they have to, to secure future business.
For a small business, pay now for a discount or pay later at a slightly higher
amount is a simple numbers game. Does it cost more to save money from a discount
for cash than the time value of money for the trade credit offered? This
time period could mean paying employees wages on time or purchase additional
materials to sell on etc. Trade credit facilities are usually only offered after
an established period of time. Suppliers providing trade credit will
normally require permission to undertake a credit check on the company
creditworthiness. With the introduction of the Late Payment of Commercial Debts
Interest Act, small businesses are allowed to charge interest on late business
debts. From recent studies however, these legislative changes have had little
impact on small business late payments and outstanding business debts.
Business Angels - in exchange for some equity in a small
business, a business angel may provide both the capital required to get the
business going all revitalise business, as well as possible expertise in a
particular industry. These business angels are basically private individuals and
investors who may provide the critical advice and capital required for
struggling businesses to survive. Business angels are typically very wealthy,
experienced, private individuals with a keen flair for business and an
entrepreneurial outlook on business. A business angel might also be part
of a larger syndicate seeking specialist investments in high growth industry
sectors. Some syndicates or angels will require control of the company and
others may take more laid-back and hands-off approach. It is important to
challenge the skills and experience a business angel claims to bring to the
table. If the Angel insists on day-to-day control and close working relationship
then any personality clashes could prove disastrous. Their primary
motivation is to see a return on the investment. Most business angels are
seeking extremely high return from businesses that can scale with funding
further funding restrictions (such as software). The business angel will
normally be as interested in the personality and attitude of the business owners
as they will the business itself. There are thousands of business angels across
the UK and it is estimated that every year they invest hundreds of
millions of pounds.
Grants and Awards - all struggling businesses may be able
to receive financial help from their local district council or from central
government. Unlike loans and other forms of borrowing, business grants are usually
refunded. It's a great way to raise badly needed cash. A useful starting
point is the local council and business Link office which will give details of
grants available in the local area. It is a good idea to meet the person in
charge of the grant decision personally, rather than just make the telephone
call. When discussing the application for the grant the criteria for its
suitability can be established and any changes made if required. It is also
sensible to produce a comprehensive business plan to demonstrate to the grant
officer that yours is an application which should deserve funding. It is also
important to establish any timeframes for the award of the family grant because
grants are usually based on annual all the regular timeframes.
Venture Capital - venture capital providers also take an
equity stake in the business in exchange for investment of capital. These
businesses are largely targeting huge funds and invest millions of pounds at a
time. Typically a venture capital organisation will raise money from other
providers in order to provide a complete package for a business. Similar to all
types of lenders, Venture capitalists will go through a due diligence process to
establish the full facts provided by a start-up business or existing business,
are accurate and correct. Venture capitalists are motivated purely by investment
return and will exit the business usually within five years.
Going Public by 'Floating the Company' - another option to
raise money is to offer shares on the stock exchange to the general public. That
option is typically for much large companies due to varying rules of stock
markets in London and elsewhere. These rules include the proportion of a
company's shares that must be allocated towards a flotation, its existing
capital size, as well as the number of initial shareholders. The most popular
market for small businesses is the Alternative Investment Market or (AIM) which
is a smaller specialised stock market and has got around 2000 companies within
it. Raising business finance via stock markets means exposing the company's financial
figures to public scrutiny on a regular basis. Its share price will go up or
down depending on the expectation of the market with regards to the company's
future performance. Any negative or bad news in the press can have a negative
impact on the amount of cash invested into that business in the future.
Debentures - the
indebtedness of a company to a creditor is acknowledged by way of a debenture.
An example of a debenture is a mortgage or freehold land owned by a company, it
being a security of the company and a charge on its assets. Debentures are
either irredeemable or redeemable. Redeemable debentures are expressed as
payable on demand or on a fixed date in the future. Should a company redeem the
debenture they can then be reissued by the company unless otherwise stated in
the company's articles. Debenture stock is money which has been borrowed from
more than one lender on the same lending terms. These lenders become a class of
creditors - their rights are set out within their trust of deed. The trust has a
committee which acts to represent the financial interests of the lenders. The
deed of trust document will have the obligations of the company owes to the
trustees. This will include the amount of loan outstanding and the interest rate
and specifically it will determine whether the loan is of a fixed or floating
charge nature. This is a highly relevant in cases where a company has defaulted
in its repayments to the debenture holders.
