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Where to go to raise finance

01 July 2010
Where to go to raise finance

As banks continue to support only the best business plans, securing backing remains fraught and fickle. Stuart Planner examines where to go when looking to raise finance.

Cash is the lifeblood of business, and its injection is of vital importance at certain times. Where to raise finance is probably one of the most important decisions you will make. The choice generally is between debt and equity, or a combination of the two.

If you are looking at the equity route, you need to consider what you are giving up and what do you expect in return?

Private equity can often provide the leverage, focus, and contacts to help your business grow faster than would otherwise be possible, but the price can be high - potentially losing overall control of your business. This might make your overall stake more valuable, but it depends very much on the initial calculation: which will grow the business more, your own stake or the investment of additional equity players? Get it wrong and you could be left with less than might have been achieved with a more cautious growth policy.

NEW RULES

It is clear that the rules on bank lending have radically changed over the past couple of years and bankers have less flexibility, becoming more risk averse. The Government is pushing the banks to lend to businesses on the one hand, while requiring them to boost their cash reserves on the other. The traditional big four banks maintain that they are lending at levels similar to the pre-crunch period, but small businesses are still complaining. So what is happening?

The banking sector in the UK exploded during the run-up to 2008, with a considerable proportion of new funds coming in from abroad. Following the collapse of Lehman Brothers much of this foreign funding source has simply dried up, leaving the traditional UK banks to cope with what was an over-inflated demand for debt.

Our experience is that the banks can pick and choose now who they will lend to, and will tend to back only the very good propositions. As to the terms, the simple loan-to-value formula is now less important as the banks look much more towards the sustainability of income streams to cover debt financing. Cash-flow is, therefore, of paramount importance, and a business plan demonstrating how the cash-flows can be sustained, or even grown, is essential, provided it is accurate and realistic. Of equal importance is the borrower's standing and experience in operating in the chosen leisure or tourism business.

So will there be debt funding available? The latest report from De Montfort University has shown that the banks have indeed opened their doors, but not widely, and the total amount of money available for property lending has increased marginally in the past year.

So funding might be available for now, maybe, but there is a debt time-bomb in the offing. It is estimated that some 70% of outstanding bank debt in the UK is due for repayment over the next five years. Finding funds to meet this demand will be difficult, with the banks becoming even more selective in deciding who they will support.

As to the terms offered in the market, these have changed considerably with a reduction in loan-to-value levels, and an increase in interest level cover. This return to "old-fashioned banking" is to ensure that the banks are not overly exposed in the event of another downturn.

EFG SCHEME

The Government, in seeking to boost lending, has sought to help small businesses through the Enterprise Finance Guarantee (EFG) scheme. This provides businesses with a turnover of up to £25m with loans up to £1m, which can also be used to convert existing overdrafts.

The launch of the EFG meant that viable businesses which can no longer secure bank lending as a result of the financial crisis can still gain access to additional funds. However, like its predecessor the Small Firms Loan Guarantee, these secured loans can be difficult to get, with only a few banking business managers being aware of the terms or availability.

As with any bank loan, EFG loans are only granted to commercially viable businesses. However, since the Government secures only 75% of the loan and banks take the full risk on the balance, the commercial risk of extending an EFG loan tends to be under tighter scrutiny. For the banks, this becomes a less-attractive option as typically they would look for full security in the current climate. When a company is unable to offer security, as is required with the other funding options, the EFG is often one of the few options up to the £1m mark. Beyond that lies the realm of the venture capitalists.

Moving away from the banks, who else is there? Friends and family, business angels and venture capitalists are all options.

Friends and family might be an option for the smaller operator. Often they are a first port of call as they appreciate your commitment as the business owner. You will generally retain control but the levels of funding are likely to be small, and strained relationships may occur if the business does not perform to plan.

Business angels are generally individual investors providing capital backing in return for a stake in the company. At least four types of businesses are well-suited for angel investment:

â- Established businesses that need investment to fund growth, or to launch a new product line.

â- Companies that require bridging finance, often because they have had to defer an initial public offering, such as on the AIM or PLUS Markets, owing to the present economic climate.

â- Companies that need funding to replace credit lines withdrawn by banks as a result of the economic climate.

Finally, looking at venture debt providers: these are generally specialist banks and no-bank lenders. The funding is often used to provide for working capital or major purchases by start-ups, which have little in the way of positive cash-flow or collateral. Venture debt providers combine their loans with warrants, or the rights to purchase equity, to compensate for the higher risk of default.

VENTURE DEBT

If you're seeking funds in excess of £5m, then venture debt providers are a serious and valuable option. Many entrepreneurs have been put off this source through fear of losing control and managing shareholder demands for quick returns. Other concerns include fears of unrealistic performance levels and an early exit, often within three years.

On the other hand, sharing or even losing control could be seen as an inevitability of expanding a business, with entrepreneurs preferring to own a small slice of a very large pie rather than all of a much smaller one.

It could be as we move forward from the financial crisis that alternative investment becomes the new normality, working with the business owners and the traditional bank funding sources, particularly if bank lending remains limited. These are interesting times after all.

Stuart Planneris an associate at Vail Williams

FOUR WAYS TO SECURE FUNDING

Funding your business remains a problem as the effects of the banking crisis and recession continue to bite. Banks have become increasingly risk averse, and opportunities to woo them have declined. Many businesses are turning to other investors, and partnerships are evolving, with family and friends, business angels, and venture capitalists. But how do you maximise your chances?

â- Know yourself. Investors invest in people. Make sure you can demonstrate your abilities to succeed. Is this a passion? Is this a project or a lifestyle opportunity?

â- Know your needs. Demonstrate where the investment will go, and what benefits will come from it - your investor needs to see a return.

â- Plan for success. Your business plan needs to be well thought out and easy to understand. The financials need to be robust and based upon realistic assumptions.

â- Be practical. You don't know what is around the corner, so be flexible to the opportunities that arise, both in the business you run, and the source of funds that might arise.

TYPICAL TERMS FOUND IN BANK LENDING MARKET

TERMS - TODAY2 YEARS AGO
- Term5 years (or less)7-10 years (or more)
- Loan to value50-60%70% or more
- EBITDA multiple6-7Around 10
- Debt service cover ratio1.3 to 1.6 1.1 to 1.2
- Margin over Libor (bps)250-300120-150
- AmortisationLikelyNone
- Base rate0.5%5.75%
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