This is somewhere between a guide and an article, I think it really depends on the approach you take to reading it.

regardless of your approach, I do hope that you glean some usefull information from this peice of work. I have it availible as a Pdf document for anyone who would like a more printer friendly version. Just message me.


INTRODUCTION

If you’ve ever been involved in a start up venture you can probably remember the effort required to raise funds when the business was set up and are quite sure that there is absolutely no opportunity for funding at zero interest rates and no payback. You know, you did your homework at the time and further you remember you cannot even raise funds without a fairly detailed and professional looking business plan complete with financial projections and sensitivity analysis. You can probably still lay your hands on that first business plan. Unfortunately most organisations have not referred to the plan since they raised the funds and only have a rough idea how actual business has compared to those original forecasts.

The difference occurs when a company has been in business for a number of years and it is this which opens up the possibility of realising what amounts to an interest free, non repayable source of business funding. The potential opportunity, however, is rarely considered as a first option when the need arises for secondary funding to develop the business.

Raising business funds is generally considered to be a tricky business. There are a number of options or routes which could be taken. How do you know which is the most suitable for the circumstances. Further to this most routes require the presentation of an up to date business plan and there is some truth in the ‘motherhood and apple pie’ statement that when you don’t need the money people are tripping over themselves to loan it to you. The second you need the money they all run for cover or start demanding personal guarantees from the directors.

This article reviews the most common sources of business funding, comments on the likely requirements to secure them and in what circumstances they are a suitable source. The article then considers why sources of funding ‘run for cover’ the second you need the money, and suggests ways of avoiding this. The article then considers the alternative ‘free funding’ option, explains how to gain access, and argues that this option should be aggressively pursued by all organisations whether they need funding or not.

Finally the article will explain why, in the opinion of the author, personal guarantees should never be given except in a small number of very precise circumstances.


TRADITIONAL SOURCES OF FUNDING

Unless you’re considering floating and gaining a AIM or full stock market listing then the usual sources of business funding potentially available to you are:

• Bank Loan / Overdraft facilities – commonly known as senior debt
• Mortgages, Hire Purchase, Lease purchase
• Asset finance
• Sale and Lease back
• Debt Finance – Factoring, Invoice discounting
• Stock Finance
• Business Angels – Private equity finance
• Mezzanine finance
• Venture Capital – Equity finance
The most common needs for funding in existing firms are listed in no particular order as:

• Acquisition
• Discharge of existing debts
• Buy out a partner
• Refurbish / expand premises
• Pay VAT PAYE and NI
• Fund new product and or growth opportunity

The type of funding you should go for depends to some extent on the use you intend to put the money to, but mostly upon the business circumstances at the time. These circumstances range from the level and quality of security available, to how well you can display an ability to furnish the debt, to future growth opportunities and, in relation to equity capital, the availability and feasibility of exit strategies.

It should be remembered that funders are in business to lend you money. They make their money by making loans at given interest rates and then having the money repaid. If you default then they are out of pocket. Risk is therefore an important consideration for funders. The higher the perceived risk the higher will be the potential return required by the funder and hence the coupon value or interest rate required.

The requirement for business plans and financial projections by a potential funder is all to do with their need to assess this risk.

It should be remembered that the lower the perceived risk, irrespective of the type of funding you are going for, the lower will be the demanded coupon rate. The more you can do to minimise this risk in the eyes of the potential funder the more chance you have of negotiating the best possible coupon rates and hence the cheaper will be the funding to the company. In some cases, of course it may be the difference between being offered funding or not.

Good security is obviously high on the list for minimising coupon rates but there are others. A company with a clear forward business strategy and an ability to display a competent committed management team will always impress. A company which knows where it’s at because it produces regular management accounts and compares its performance with forecasts is a pre requisite for some forms of funding but will go a long way to minimising the perceived risk in all areas. This is particularly the case if the forecasts can be seen to be realistic and achievable and managers are seen to take corrective action when performance departs from plan.

Obviously a company with the appropriate financial controls and an ability to operate efficiently and competitively in its chosen market reduces risk. There should be no significant threats to the market segment or niche within which the company operates.

Finally funders will want to take a look at previous forecasts and compare them with actual performance. A sensible explanation will be required for any serious adverse variances.

With all of this in mind a quick commentary on the types of funding and their general requirements will be useful.


REQUIREMENTS OF THE TYPES OF FUNDING

Given the importance of security and risk we will deal first with the low risk secured funds end of the spectrum first.

If you’re looking to make a one off purchase of a piece of equipment then hire purchase or lease hire is probably the way to go. Which particular version will depend upon the VAT treatment and the company profitability in relation to capital allowances. The point of this type of funding however is that it is secured against a specific asset, the one you are buying. If you default there is no debate, the asset belongs to the hire purchase company and can be recovered with little expense or effort provided the asset is clearly identifiable. The HP company will require a means of unique identification such as non removable serial number and evidence of your ability to meet the repayments. Unless we are talking significant amounts of money in relation to the size of the company, the repayment test is likely to be met by provision of statements and latest accounts.

Given the clarity and quality of security HP loans can usually be arranged at relatively low interest rates and are often cheaper than conventional bank loans.

Most people know and understand the concept of mortgages for property. Security is clearly identified and of good quality. The emphasis is therefore on ability to service the debt. Mortgages tend to be taken over an extended number of years and hence the requirements to display the ability to pay are likely to be greater. This is likely to increase as the number of times cover of existing profits over repayments reduces.

Lower cover ratios are more likely to require full business plans and forecasts in addition to recent and historical accounts.

It is generally accepted that your ability to borrow senior debt should be maximised before considering other forms of loans. This really is a statement of using the cheapest source of funds first. Conventional Bank Loans and overdraft are therefore the next level to be considered.

Security is taken by a fixed and floating charge over the assets of the business. Such funding can usually be secured at 2 to 3% over base. Bank loans and overdrafts at any significant level will almost certainly require the presentation of a business plan in support of the application. Additionally the bank is likely insist upon the presentation of monthly management accounts complete with variance analysis and debtor and creditor lists. They may also require a formal valuation of the assets and if so you will have to pay for this.

The amount of security the bank will consider your assets worth is worthy of comment given that you may exhaust this source of finance quicker than you thought. When evaluating your assets the bank is interested in two things. Firstly their forced sale, or fire sale value, as it is known, and secondly how clearly and crisply will their fixed and floating charge give them priority to these assets.