Finance is vital for supporting growth at any stage of a business's life. Typically at the start of a business, funding will come mostly through personal investment. The advantage of a personal investment is that you are in total control, no one else needs to be a part of the decision-making. You also keep 100% of your business and don’t have to pay any of the profits in loan repayments.
However, there comes a time when growth needs to be supported by more than personal funds or profits from the business itself.
How do small and medium enterprises (SMEs) secure finance that can help them maintain or accelerate business growth?
When to think about business financing?
Emily Cuddeford is co-owner of Twelve Triangles, a growing chain of bakeries, cafes and delis in Southern Scotland. From a single outlet in Edinburgh, the company now has eight shops and 50 staff, with much of that growth coming in the past two years as the company doubled in size.
“Our original investment in the business came from Rachel who founded the business and is my business partner," says Cuddeford.
"Over time, we’ve had a mixture of funding options, from asset finance for equipment to government-backed grants.”
The right time to think about all your business financing options is as soon as possible, according to Parry Jackson, Partner at Price Bailey Chartered Accountants.
“Most businesses should consider funding at an early stage in their life, especially where they have aspirations to grow,” says Jackson.
“Those businesses either in their start-up or growth phase will need to understand the capital needs of the business to survive and ultimately thrive in the longer term.”
Let’s look at some of the most common ways to raise capital and finance a growing SME.
Family and friends
Your growing business may prove to be an attractive investment opportunity for family and friends. Unlike a large organisation where they may not know much about the company, they will be much closer to your enterprise and understand the day-to-day working of your business.
However, borrowing from family and friends can be difficult, as people become emotionally involved and may have different expectations. They risk losing their investment if your business fails and there can be a temptation to avoid formal agreements, which can cause problems later on. This can also lead to legal issues if the finance is not properly accounted for. Both business owners and potential investors should take outside advice and formalise the terms of the financing to avoid conflict.
Equity investment
In return for offering a share of your business (or ‘stake’), equity investment is a useful way of accessing a lump sum for expansion. The added advantage is that it doesn’t need to be repaid in the same way as a loan.
Equity investment can be particularly helpful at the start of a business, says Jackson.
“Businesses in their start-up phase may struggle to obtain debt finance due to the lack of credit history and as such it may be that equity finance is sought,” he says. “As an example, technology businesses developing software would be a good candidate for equity funding whilst they get their product to market.”
Selling equity in your business can also be a way to fund a major expansion. However, in return for a stake, equity investors will expect to see a return on their investment and may also wish to have a say in how the business is run.
Jackson warns: “Meeting the expectations of investors can increase pressure on business owners, it can be helpful in instances where investors have experience of the industry in which the business operates.”
Crowdfunding
Crowdfunding is a variation on equity investment. Instead of a single individual or institution investing and taking a stake, the investment comes from a large number of small investors. Instead of a share in the business, they may be offered other incentives such as exclusive investor rewards, early access to products, or discounts.
Business loans
These cover a range of funding options, from short-term loans up to around 18 months and help out with cash flow, while longer-term loans can be anything from two to 10 years or more, and are typically used for big investments. The business will usually have to complete an eligibility check, demonstrating how long it has been running and its creditworthiness, which will determine how much it can borrow.
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Asset Finance
Asset finance is a specific type of loan that, as the name suggests, is linked to the company’s assets. “A year and a half ago we took out asset finance to do a large-scale upgrade of our bakery equipment," says Cuddeford.
"Instead of taking £120,000 out of the business to pay off over four years, we used asset finance.”
Cuddeford explains that, while the equipment upgrade didn’t cause an immediate uplift in sales, that wasn’t the purpose. Instead, it is a long-term investment that allows for better staff retention and higher-quality products. It also meant that the equipment would last much longer. Had she bought a less expensive upgrade that may not have needed financing, it would also have needed replacing much sooner.
Business grants
Grants can be a helpful way of accessing business finance, primarily because they don’t need to be paid back. Grants have been issued by a range of institutions, from Government to professional bodies, larger companies or associations and usually come with terms attached. These include hiring a certain type and number of staff, engaging in training or investing in the local economy. You may also be asked to match the grant funding, and prove it has been used for the purpose it was supplied.
Many businesses, including Twelve Triangles, received COVID grants which helped the business during lockdowns. Today, the company isn’t in direct receipt of grants. However, it is making use of tax breaks given because the company is reinvesting in the local economy.
Which is best for my business?
Different forms of finance can be more appropriate than others for different types of businesses, says Jackson.
“Freight businesses that need to grow by acquiring vehicles will be a candidate for asset financing, for example," he says.
"Businesses with larger working capital cycles may benefit from working capital facilities or invoice factoring (where third parties pay your invoice early for a fee).”
Jackson also adds that it pays to keep an eye on the economy, as that can also influence the type of business finance that might work best for you.
“Debt finance has become more expensive in recent years and therefore any ways business can be smart with capital (maximising credit terms, obtaining grants) will be a bonus,” he adds.
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