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STRATEGIC FUNDING – Where to find the capital your business needs – Part I

Funding growing businesses is one of the major challenges any entrepreneur and business owner will face, and while there is an increasingly vast array of options available, figuring out how to access these funds can be a very time consuming, frustrating experience, even for the most seasoned business owner.

Whether you need working capital to support your growth, raise funds for a push into a new market, introduce a new product range or even have a requirement to raise funds for a new business venture, figuring out what you need to do and where to go can be difficult. With the advantage of “doing this for a living”, this report summarizes the process and points you in the right direction in terms of funding providers and where to go to get the independent specialist advice you are likely to need.

Highlights

  • Which type of funding will suit your needs?
  • Sources of funding (including advantages and disadvantages of each one).
  • Where to get independent specialist advice on your funding options and presenting your case for the best chance of success.

Introduction
Whether you need $1,000 or $10 million, there are only two kinds of finance: equity, whereby you are raising money in exchange for for ownership of the company, and debt which is borrowed money. The first step in raising capital is to decide between equity or debt. In the SME world, the choice usually depends on the preference of the business owner and stage of the company.

If you want to maintain total control, you are typically going to prefer a debt driven funding route: however if you are less worried about control, bringing in equity funds can often mean you grow faster. This can be a good route, particularly where you have a very clear exit in mind and this exit lines up with other equity providers.

In most SMEs the entrepreneur or business owner is the person who looks for funding the business needs. When raising debt finance, our experience is that banks are still the most frequent form of funding used, but increasingly owners are hearing about and starting to use new forms of finance outside of traditional banks. This so called alternative funding market is growing rapidly, and has more than doubled in size year on year from £267 million in 2012 to £666 million in 2013 to £1.74 billion in 2014, according to the “UK Alternative Finance Industry Report”.¹

Equity financing can come from individuals, so called angel investors, and traditional venture capital firms. Depending on your ambitions, there is also the option to combine both debt and equity in a funding mix to provide the capital base for long term growth and the working capital to support working capital requirements in the business.

While there is copious advice for those businesses seeking to raise funds for start-ups, this report focuses particularly on the challenges facing mid sized companies who are past start up and need funds to continue to grow (those with annual revenues between £2M and £50M, or employing staff between 10 and 250 employees).

Sources of funding for mid-sized business

Bank Operating Line of Credit

For many businesses the bank operating line of credit remains the traditional form of funding, with relationships formed over many years.

Although lines of credit can be quick to set up, the biggest drawback is that they can be called in by the bank on demand. So when things aren’t going well and you need the facility, that’s just the time when the bank might demand repayment, particularly if you haven’t built a strong relationship with the bank, so they understand what’s going on in your business.

Loans

A bank term loan will have a maturity date and require principal repayments over a fixed period of time (typically 2 – 5 years). As long as you payback the money per the terms of the loan, the advantage is that the bank can’t demand repayment, although typically the business and usually the owner will need to offer strong security for the loan, usually secured on the assets of the business and often the owners personal assets, by way of a personal guarantee.

As with operating lines of credit, the irony is that the more profitable and cash generative your business is, the less likely the bank’s requirements for security.

The principle is straightforward: if your business has performed well over the years and the bank has confidence that performance will be continued, then the easier it is to borrow money against security, or in some cases simply the cash flows of the business.

Invoice Discounting (Factoring)

Invoice discounting, also referred to as factoring, has grown in popularity in recent years. Banks and other specialist invoice discounting firms lend money which is secured by your accounts receivable, so if the company fails, the bank or specialist firm has more security than in the case of a conventional credit line.

With invoice discounting, you effectively sell your outstanding business invoices to a third party. You get the cash flow benefit by receiving a percentage of the money immediately (usually around 80%) and the rest when the money is collected.

Invoice financing can be really beneficial for growing businesses and can help you to bridge the gap between the delivery of goods or services and the payment from your customer.

Asset Financing

An important consideration of financing, is the overall mix of funding a company uses. Asset financing can be used for funding fixed assets such as plant and machinery, equipment, computers and vehicles. All the main banks have asset financing arms and there are also many specialist companies in this space. The bank or finance company takes security of the asset as their protection. This form of financing has the benefit that it is pretty easy to arrange, assuming the assets you are buying are standard.

There’s also another type of financing: the alternative financing.  Come back for part II of this article, where we will discuss these alternative financing sources.

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1 ‘Understanding Alternative Finance: The UK Alternative Industry Report 2014’, Baeck, Peter; Collins, Liam; Zhang, Bryan, Nesta & The University of Cambridge, November 2014

Scale Up with The CFO Centre - Cashflow

How your business can fly away from cash problems

Do you ever feel that growing your business is like being a bird in a cage? Even if it’s a big cage, it’s still got its limits. For your business, that “cage” can be a lack of cash needed to let your business fly as high as it can.

It shows up when you’re hit with a lack of cash to hire new people, to move to larger premises, or to invest in R&D to upgrade your products. It’s your accountant warning that you’re short on money to make payroll or pay the rent, or your bank asking you to replenish your accounts.

Sometimes, cash flow issues intrude if business is slow, and your fixed payments such as rent and utilities eat up too much of the small amount of revenue that comes in.

But cash can also be a problem if your wildest dreams come true and you have too successful a business. If you need to hire staff, buy inputs like parts and raw materials, and buy and install equipment, that means a lot of cash going out if you’re to meet your customers’ needs (see our post on “Hypergrowth” for more on that).

Even if your customers pay right away, you’re still left holding your financial breath until that money’s in your bank. And you may need to hold your breath a lot longer if your customers take 30, 60 or even more days to pay.

Success-induced cash flow problems are particularly problematic for scale-up companies, because their cash shortages are often much larger than those of startups. Smaller companies can dig into their home equity, a personal line of credit or friends and family. But scale-ups’ cash demands are often too big for those startup-type solutions.

It’s like learning to swim – in the shallow end of the pool you can always put your feet on the bottom. But at the deep end, that’s not an option.

Learning how to deal with those deeper waters starts by understanding how your company can get into cash flow problems in the first place.

What causes cash flow problems?

According to the CFO Centre’s e-book “Cash Flow,” the main causes of cash flow issues are:

Slow-paying customers: Customers may be facing their own cash flow problems and may be inclined to drag their heels on paying your company. There’s often a gap between the time you pay for the inputs to your product – including paying your staff – and when your customers pay you. You may be reluctant to press for payment, partly because you don’t want to alienate or lose a customer, but some customers will take advantage of that.

High fixed costs: You may be paying too much in rent or payroll, because in the optimism of entrepreneurship, you expect to need that capacity sooner rather than later. But your “sooner” may be taking its time arriving. When in growth mode, you’re likely paying more for inputs and fixed costs than you’re bringing in as revenue, so all costs need to be monitored regularly to ensure that you’re not spending too much.

Your prices are too low: You may be trying to win customers, particularly in a market where prices are easily comparable, but if you’re not covering your costs or giving yourself a healthy margin, you risk running out of cash. Customers who choose only based on prices will likely jump to a competitor if you increase what you’re charging.  Understanding your costs and developing your pricing model accordingly is critical.

Other common reasons include low sales volume, too-generous payment terms, bad debts and too much old inventory.

How to get the help you need to avoid cash flow problems

Most entrepreneurs would rather focus on growing the business than watching over the finances. That’s even more so as the business gets bigger, and the cash flow picture becomes more complex.

This means that growing companies can benefit from specialized financial expertise. Sometimes, that expertise is available within the company, but more often, it’s necessary to look outside.

A professional with financial expertise can help you recognize warning signs you may have missed as you focused on growing your business. This person can then help you find ways to deal with those issues, such as pressing customers for faster payment. There may also be opportunities for other ways to deal with your financial crunch such as vendor financing or R&D tax credits, that you may not have fully explored.

For many companies, that means a need for the skills of a Chief Financial Officer, but maybe without the price tag of a full-time CFO’s salary. A part-time CFO may be the answer – someone who is fully part of your leadership team, but on a basis that may range from a few days a month to a few days a week.

The CFO Centre’s “Cash Flow” book provides some suggestions on how to deal with possible cash flow problems, as well as describing your options as regards a part-time CFO.

Scale Up with The CFO Centre

Is the problem your company solves BIG enough?

If you have ambitions to grow your small company into a large one, you need to make sure it has room to grow.

To see how that works, consider that humble box of baking soda in your refrigerator. Baking soda was originally developed for, well, baking. It solved a baker’s problem – the difficulty of getting baked goods to rise. But then, people discovered other problems the product solved – diaper rash, kitchen fires, grease stains … and refrigerator odors.

Manufacturers such as Arm & Hammer found demand for their product that was quite unrelated to their company’s original idea.

But what Arm & Hammer found out indirectly about solving wider and bigger problems, you need to do intentionally. How do you do that? Here’s a three-step process.

1. What problem(s) are you solving now?

You may have started your business to provide a specific product (such as baking soda) or service. But your customers may look at the situation quite differently. They’re looking to buy a solution to a problem they’re facing, like diaper rash or a carpet stain. Sometimes, it’s more than one problem – a box of baking soda helps bake cookies and helps clean the kitchen counter.

So, you need to get a clear idea of what problems you’re solving for your customers now. To do this, consult with your customers directly, get input from your sales team, and see what people are saying about you on social media.

Then ask yourself: are the problems we’re solving now the problems that will help us continue to grow? Should we be solving different, maybe bigger, problems?

2. Find the right bigger problems to solve

The world is full of bigger problems – climate change, overpopulation, civil unrest, and many more. But how do you find the right bigger problems? Some ideas that may guide your quest:

Do people with money feel this problem? If you’re running a business, you need to earn revenue – so the problems you solve must involve people who have the money to pay you. And, the problems must be pressing – those ideal customers must actually feel the pain and urgency enough to want to pay you to solve those problems for them

Does this problem give meaning and urgency to your life? As well as pressing on your customers, the problems you’re solving must motivate you. They have to help you get going in the morning and stay at it all day. Only then will you be able to motivate others on your team, even those who don’t interact directly with customers, to help solve those problems too.

Does this problem have staying power? You need a problem that will continue – and better yet, continue to grow. Only then will you have the basis for a business that has sustainability.

Now, let’s consider how you can bake that sustainability into your business.

3. Develop a solution that’s disruptive

If your answer to the problem of refrigerator odors is another box of baking soda, you may need to re-think your approach. You’ll be struggling against a well-entrenched competitor.

Instead, the solution you offer must be disruptive – in other words, it must be unusual and offer new solutions to existing problems. One reason is that if it’s a big enough problem, it won’t be solvable by current thinking, or someone would have solved it already. And, you need to seize attention, and offer an advantage compelling enough so that potential customers will say, “I want some of that.”

Our work at the CFO Centre is something like that. We saw a problem – entrepreneurs whose dreams crash to earth because they don’t have the financial lift they need under their wings. And we saw that many companies can’t afford a full-time experienced CFO (that cash problem again), and what’s more, they don’t need one.

What many (we like to think all) growing companies can use is ongoing access to a CFO’s ability to clear away the financial stumbling blocks, but without a full-time CFO’s cost. So was born our “fractional” CFO – a permanent, but part-time, financial advisor.

That’s our disruptive solution.

One thing we’ve found out is the importance of having the cash you need to build a way to solve the “big problem” you’ve decided to focus on. Without cash, it’s like you’re trying to walk when you need to fly. To learn more about the importance of cash flow, the reasons for it (such as slow-paying customers, high fixed costs), and some steps you can take to resolve them, download our free e-book, simply titled “Cashflow.”

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