Get equity or go online? The ways to fund your firm
Published 14/05/2015 | 02:30
What are the different ways you can get funded? It's a question not many SME owners consider, usually taking the option to go straight to a bank. However, there are several equally effective ways of securing funding that can fit your business better than getting a loan from a bank. We take a look at some of the different methods of funding an SME:
1 Working Capital
This is the finance that businesses need for their day-to-day trading operations. All businesses require working capital, but sometimes they are unable to access the cash they need because they have to wait for large invoices to be paid - sometimes for up to 90 days.
There are several types of solutions to working capital, with the first being invoice financing.
Invoice finance allows a business to draw money against its sales invoices before the customer has paid. To do this, the business borrows a percentage (up to 90pc) of the value of its sales ledger from a finance company, effectively using the unpaid sales invoices as collateral for the borrowing. So your business has instant access to the money your customers owe you.
You remain responsible for collecting the invoice payments, so your customer is unaware of the financing agreement. The finance company will charge interest and service fee.
The second type of working capital is leasing. A lease agreement is a contract between two parties, the lessor (owner of the asset) and the lessee (user). The lessor is the legal owner of the asset, the lessee obtains the right to use the asset in return for lease payments. At the end of the primary lease period you can return the asset or continue to use it through a secondary lease agreement. Leasing can be utilised for most assets and is commonly used for commercial vehicles, office equipment, plant and machinery.
2 Loan Finance
Business lending includes commercial mortgages, equipment lending, and loans intended for expansion. Loans will have a fixed term and the interest rate applied can be either fixed or variable. Capital and interest repayments will be scheduled over the term.
The main providers of loan finance to the SME and startup sector are the banks. Most businesses will need to borrow money at some stage either to help with cash flow, or to pay for expansion costs, and a short-term business loan can provide the ideal solution. A short-term business loan can be invaluable for businesses that need a cash boost if they are expanding, or if they need a bit of extra help to manage their cashflow.
This type of loan usually has a term of six months, so must be repaid quickly. You can usually choose a fixed rate of interest, so you know repayments will be the same every month, or a variable rate, which could mean your repayments change over time. Instead of a short term loan, SMEs can also opt to take out loans over a medium to long term period. A medium to long-term business loan typically enables you to borrow to help your business for one to five years. The loan is repaid in monthly instalments, with interest added to the amount you owe.
The main advantage of opting for a short-term business loan is that you know your business will only have to make repayments for a limited period of time. You will also usually pay less interest overall than if you opted to repay what you owe over a much longer term, such as five years, although interest rates can be high on short-term borrowing, so it's worth comparing lots of different loans to ensure you find the right deal for your business's needs. On the other hand taking out a business loan over a longer period may mean your payments are lower than if you'd opted for a shorter term loan, but ultimately you will pay more interest overall.
3 Equity and Angel investors
Angel investing is equity finance. The range of angel investors includes private individuals, private investment firms and institutional investment funds. These investors provide investment capital to established businesses and seed capital to startup or early-stage businesses. In return for providing capital, angel investors acquire equity shares in the companies that operate the business. Individual and institutional investors not only provide money, but they can also bring their experience to help businesses achieve success. The percentage of equity angel investors will want will depend on the level of investment required and the stage of development the business is at. Typically, angels will seek a return on their investment over a period of 3-8 years.
On the downside, depending on how selective you are it can take a long time to find a suitable business angel investor. You also have to come to terms with giving up a share, and some control, of your business.
Equity firms or venture capital companies usually make larger investments than angels, making them suitable for bigger companies. However, VCs require due diligence before investments can be made which may require more expensive professional advice and time compared to angel deals.
VC companies will invest in SMEs which will give them a multiple of the investment, usually within 3-5 years. This means they will need preference shares in the SME which will include anti-dilution clauses and liquidation rights. They are likely to have a more formal relationship with the businesses they invest in and to build exit procedures into agreements.
The benefits of equity firms is that they will invest in the company and usually not require personal guarantees of the SME director or owner.
4 Peer To Peer
Peer To peer finance can be broken into three different types. First, peer-to-peer lending (P2PL) is the practice of lending money via online platforms to unrelated individuals, or "peers", without going through a traditional financial intermediary such as a bank or other traditional financial institution.
Second, is peer-to-peer investing (P2PI) this lending takes place online too on peer-to-peer lending companies' websites using various different lending platforms and credit checking tools.
Third, crowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people via online platforms. Crowdfunding is driven by three types of parties. The project initiator who proposes the idea, those who support the idea and the online platform that brings the parties together to launch or fund the project. The main advantage of peer to peer finance is its accessibility for both funders and SMEs. Generally, the range is not confined by geography, finance type, amount or timeframe for both funders and SMEs.
Also, via P2P platforms, the application process can be completed in weeks rather than months as can often be the case when dealing with banks. However, the quicker application process and less onerous security requirements could leave SMEs incur debt they cannot afford. The other main advantage for SMEs is that the interest rates are fixed for the duration of the loan, so you do not have to worry about future rates rises. However, repayment periods are often quite short, typically between three and five years, which may be too onerous for some SMEs.