Raising £1m to £5m: The growth finance options for your business

There's plenty of options for entrepreneurs seeking £1-5m - but what's right for you?


Online borrowing and lending site Zopa.com, set up in March 2005, was seeking finance to expand in the UK and to launch in the US. It set its sights on venture capital (VC), laid down a strict timetable and raised just under £2.7m in June this year.

“We knew we needed VC funding. We needed someone who would help us grow the business, work with us to take the company into the US, enhance our reputation and be able to continue funding us over the next two to four years,” explains James Alexander, the website’s co-founder and UK chief executive.

Expanding your business at home or abroad is just one the many reasons you will need an injection of cash. You may recently have won a large contract, be about to launch a new service or product to the market, or are perhaps considering buying a competitor. Alternatively, you may have recently moved to bigger premises or need new equipment – all of which puts a strain on your working capital and cashflow.

The good news is there is no shortage of funding options for businesses like yours, from high-street banks and private equity to a flotation on the stock market. You can even raise cash against unpaid invoices or your company’s wage bill.

But each option has its own set of requirements, and some will not be suited to your business. The time it takes to raise money will also influence your choice. Bank loans can quickly be arranged, whereas private equity deals and a flotation can come at considerable time and cost to you and your management team.

Where to go

Your high-street bank is often the cheapest option. Bank loans vary from provider to provider, so it’s wise to shop around. Lloyds TSB and Barclays, for example, offer a base rate loan from one to 20 years, with capital repayment holidays. They also offer fixed loans and commercial mortgages to help buy a new building or release cash locked up in your existing premises.

According to Rob Donaldson, corporate finance partner and head of private equity at chartered accountants and business advisers Baker Tilly, banks are a trusted form of third-party debt.

“At the moment, finance is widely available in the current low-rate environment for those with a strong track record or significant assets for security,” he says. “However, high-growth situations coupled with losses or poor cashflow are difficult for banks to finance.”

Banks will require a business plan, details of company assets and liabilities and historic financial accounts. As Nigel Le Bas, a corporate finance executive at accountants and business advisers Tenon, points out, one of the advantages of bank funding is that you are able to retain 100% ownership of the business. On the downside, the funding available is limited by security and you may not be able to raise the necessary amount. Most importantly, the bank will require security in case of default.

Despite banks being many business’s first port of call, Zopa’s Alexander warns against going down this route.

“I would never suggest starting with high-street bank funding,” he advises. “Debt finance is an option – but it becomes a better bet once the venture is partially established. Do you really want to lose your house if your business does not perform? Always start with equity finance unless you have a lot of savings.”

Mixing debt and equity

If you are looking to fund the expansion of your business, consider mezzanine finance – a mix of debt and equity. As it is a higher risk than senior debt, mezzanine finance has a higher interest rate, and usually carries a small warrant over the ordinary shares of the borrower company.

“The drawbacks are that it is a more expensive form of debt and it usually comes into play when your company has exhausted all other routes of conventional debt,” says Karen Davies, an investment executive at Finance Wales, which helps businesses based in the country raise funds.

But it does have its advantages – on the balance sheet of a company, mezzanine finance is treated like equity, which may make it easier to obtain standard bank financing.

“Mezzanine also does not involve a significant dilution of the shareholders’ equity. Providers do not receive voting rights, and, therefore, are more likely to leave the running of the business to management,” says John Clifford, from the growth and acquisition finance division at mezzanine provider Investec Private Bank.

Another significant benefit of mezzanine finance over a senior loan is that you do not usually have to repay it for potentially up to eight years. This is similar to the difference between ‘repayment’ and ‘interest-only’ mortgages. In other words, cashflow generated by your company in the early years of a loan can be reinvested in growing the business, rather than repaying debt.

It can also be a relatively quick way to raise money – providing you have done much of the necessary paperwork beforehand, as it involves a fair amount of due diligence on the business and your management team. Investec’s Clifford says that a deal can be done in as little as three weeks, although a six to eight-week turnaround is the norm.

New wave finance

In the last few years, alternative ways to raise cash have emerged. Companies such as Wageroller and Smart Flow Finance offer cashflow financing services based on a company’s wage bill rather than its order book. Wageroller offers a nine-week rolling credit facility to pay up to two months of your company’s wage bill. According to Lee Tumbridge, marketing director at Quest4finance, which provides the Wageroller service, it can be used to pay suppliers at a discounted rate, buy new equipment or take on new business.

“It requires no personal guarantees or termination fee and a minimum contract period of only three months,” says Tumbridge.

Although it’s not an option if you have a poor credit rating, wage bill fi nance is a fast way to raise cash. You can apply online, details are cross-checked with Companies House and credit reference agencies, and applications are turned around in three days maximum. The only limit is the size of your wage bill – over a month you can raise twice its value. Once approved, you process your payroll as usual and use the fi nance company instead of your usual bank facility to make staff payments.

“It’s simple to set up and is a complementary fi nance option that works alongside any other borrowings you’ve got,” says Henrik Platou, marketing director of Smart Flow Finance.

Expect to pay interest at around 3% above base rate with a one-off set-up fee and ongoing management costs – or, as with Wageroller, no set-up charge but additional interest based on average monthly borrowing.

Invoice finance

You could also consider raising cash against your unpaid invoices, realising debt before it is paid. Invoice fi nance is offered by both banks and specialist lenders. If your business is fast-growing and profi table, but in need of a cash injection because your working capital requirements are growing, it’s an option to consider.

Tony Mayes launched document shredding company Shred Fast in 2001, which is on course to reach a turnover of £2m by the end of this year. Cashfl ow problems plagued the business in the early days and Mayes had ruled out overdrafts and loans due to the high interest rates. “We had nearly a quarter of our turnover tied up in unpaid invoices, highlighting a serious problem with the way we were managing our cashfl ow and balancing money coming in and out of the business,” says Mayes.

Unimpressed by his bank’s invoice finance rates, Mayes arranged one with invoice finance provider Bibby Financial Services, which provided him with 75% of the value of his invoices within 24 hours of them being raised, with the remaining 25% advanced to him on receipt of customer payments, easing cashflow problems.

The Royal Bank of Scotland (RBS), another invoice fi nance provider, says there has been an increase in the use of such finance as an alternative to bank loans. “Business owners may be able to avoid securing borrowing through personal guarantees because working capital is provided against outstanding sales invoices. In addition, you won’t need to renew it every year,” says Alex Rankin, director of commercial UK at RBS Invoice Finance.

Flying with angels 

For higher risk growth capital opportunities, private equity – raised through business angels or VCs – is an attractive option. The typical investment period for VCs is two to five years depending on stage of development, sector and business model.

Angels typically invest up to £250,000, so VCs are your best bet if you want to raise £1m plus. But if larger sums of money are involved, a group of angels may come together in a syndicate, spreading risk. Angels also come with a wealth of business expertise and contacts. VC funding is expensive, and you will be expected to give a lot in return.

“Legal costs alone will eat up five to 10% of what you raise. So get a good options pot agreed – you’ll need it. Investors buy people, so your management needs to be experienced and up to the task. If possible, have some revenue that proves the model or some agreements in the bag before you start trading,” says Bill Kirkwood, chief executive of Site Confidence, which monitors website performance. It has done several private equity funding rounds, most recently last year when it raised just under £500,000 from private investor group Katalyst.

On the upside, a VC will bring top level expertise, such as international expansion experience. “Getting new backers brings diversity to the shareholder base and adds complementary networks,” says Ian Lobley, senior partner at private equity firm 3i, which has a specialist growth capital division.

Taking aim

A flotation – either on The Plus Markets (previously known as OFEX), or AIM, is also an expensive option, but it can secure funding for the long-term. Hydrogen, a group of recruitment companies, floated in September, raising just over £6m.

“We chose AIM because it gave the right platform for the next 10 years of the group’s development, allowing us to have access to capital for its continued organic growth, found new recruitment consultancies and raise the profile of the Group. But make sure you’re doing it for the right reasons – the market is discerning and demanding,” says Hydrogen chairman Ian Temple.

Raising finance on AIM has a fixed cost, typically at least £300,000 – and that’s excluding professional fees. Engineering company Servocell floated in March, raising £5.5m, but it cost £850,000 with legal and professional fees.

“Raising less than £5m on AIM can be expensive,” says Steve Weaver, chief financial officer at Servocell. “Try to meet people who have been through the process and find out how much they paid, as it is important to have a benchmark before agreeing fees.”

Revising Weaver’s assessment, Mark Dowding, a partner at accountancy, taxation and business advisory group Vantis, says businesses need, in most cases, to look at raising more than £2.5m for AIM to be cost effective. Below this level, Plus Markets is a sensible alternative. “During August, 29 companies were admitted to AIM, of which eight raised up to £5m. While Plus Market’s profile is lower than AIM, so are the costs associated with a fundraising, and it is increasingly being seen as a ‘stepping stone’ to AIM again,” he says.

With the range of growth finance options available, it pays to examine your requirements carefully and weigh up what you are prepared to sacrifice in terms of time and money. And when it comes to raising the cash, there are two rules that all entrepreneurs are in agreement about. Make sure you raise enough – you will always underestimate how much you need. And securing the finance will always take longer than you think.

Case study: The quest for finance

Company: Actinic

Chris Barling, chief executive officer and co-founder of e-commerce and electronic point of sale systems supplier Actinic, has taken his company through a variety of financing options in its 10-year history, including business angel funding, venture capital and a flotation.

The business raised around ?1.7m over four funding rounds before fl oating on the Alternative Investment Market and raising ?25m (although it has since de-listed). During the fundraising stages, few people believed that e-commerce had a big future, and even fewer wanted to back the company, as neither Barling nor his co-founder had experienced previous success with a venture capital-backed business.

?We followed every money-raising lead we could, and we presented to a lot of people ? around 70 in the end. Banks aren?t too interested in early stage, high-growth businesses, but it may be different if you give a personal guarantee,? says Barling.

?We were very flexible about the amount we were raising, the conditions and the equity given away. We had to be prepared to re-do the business plan more times than I care to remember.?

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