How to determine and obtain the right type of finance to support growth

Most SMEs approach their bank when they need funding but traditional banks are no longer always willing or able to provide growing businesses with all the finance they need. Gone are the days when they would give you an unsecured overdraft or a medium-term loan to fund working capital. So, you have to look for an alternative. The good news is there has probably never been a better range of finance providers than right now – challenger banks, debt funds, peer to peer lenders, angel investors and private equity funds are all sources of funding for SMEs.

Business growth can come in many forms so you need to get funding that is most appropriate for it. If you are investing in working capital such as hiring more staff or buying more materials, for example, you will need a different type of finance than if you are buying equipment or bigger facilities.

There are two main types of funding for SMEs – debt finance, which involves borrowing money and paying it back over time, typically in regular monthly instalments; and equity investment, in which you give up equity in the business in exchange for investment. The equity investor then owns a proportion of the business and receives a share of any profit the business makes when it trades and on any capital event, such as a sale.

Debt finance options include invoice discounting, in which an invoice finance company will lend you a proportion of the value of an invoice as soon as you have raised it; peer to peer lending through a platform such as Funding Circle, and asset finance, in which the funding is used to fund the purchase of an asset such as new equipment.

Equity finance options include angel investors, private equity funds and crowdfunding.

If your business is growing steadily and generating consistent profits – a manufacturing firm, for example - then you are likely to be able to borrow money as debt finance and pay it back each month in a structured way.

If your business is on a very fast growth curve, however - for example a tech business - it is likely to need a large amount of money early on in its life cycle to scale up, which it may be unable to repay through regular repayments. In this case giving up a share of equity to a private equity fund or angel investor would make more sense because there will not be any immediate need to repay the money which would put a strain on cashflow.

SME founders can be fixated on how much they own of the business but if giving a percentage to a private equity fund, for example, enables the business to grow faster and ultimately grow value, they will end up with a smaller slice but of a bigger pie.

The advantage of asset finance, for example, is that it provides certainty for your cashflow and forecasting models because your monthly repayments are fixed. The disadvantage is that the lending is secured on the assets so if something goes wrong in the business then typically the lender will have a legal charge secured on the asset.

The advantage of invoice discounting, meanwhile, is it can scale up with the business. The disadvantage is that it is not suitable for some sectors, such as professional service businesses and can be relatively expensive.

Create forecasts for your profit and loss, balance sheet and cashflow which include the impact of the funding you are looking for; if you are going to spend it on increasing production capacity, for example, then show how sales will go up, and how you will be able to make the monthly repayments. Also boost your credit rating by paying your suppliers on time – very large companies share their customer list with credit rating agencies and so paying late could have an impact on your rating.

For more information on the right type of funding to help grow your business contact Nick Parrett today.

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