With regards to valuation the bank has to be mindful of the process involved in realising cash if they have to rely upon their fixed and floating charge to recover the debt. The assets will have to be sold quickly at auction. There will be auction fees and, in all probability, Insolvency Practitioner fees if by this time the company has entered administration. Insolvency Practitioners charge according to a fee structure regulated by their controlling body. There are 7 or 8 such controlling bodies. Take a £1m turnover company. The IP fees would be in the order of £25k if they are on the banks approved list. The IP’s ‘expenses’ have to be added on and the cynics in life would say that the level of expenses will be proportional to the realisable value of the business. This article does not wish to debate the validity of otherwise of the cynics view and simply wishes to draw attention to potential costs to be considered when valuing assets for security.

Ignoring debtors and creditors for the time being a general rule of thumb would be to take the net book value of the other assets and divide them by three. The resultant value is, give or take, the value up to which you can arrange secured loans.

This obviously does not apply to property, which can be considered as security up to 100% of its value.

The second consideration with regard to security is the crispness to which the fixed and floating charge will give priority to the holder of the debenture.

Last century there was little concern about the priority of a fixed and floating charge and banks were happy to include debtor book in the assets considered for security. This was a useful and certain source of funding which is no longer available.

In 1999 the Brumark case changed the banks view. Anyone interested in the detail of the case can no doubt find it on a web search but essentially unless separate bank accounts were used, the banks priority over debtors afforded by the fixed and floating charge could not be upheld.

Invoice factoring has been around for a long time but Brumark case made it the only effective way of funding with a debtor book as security.

There are various versions of this type of funding ranging from Confidential Invoice Finance through Invoice Finance to full Factoring service. Confidential Invoice Finance is a means of raising funds on the debtor book whilst you continue to manage the ledger and collect your debts as they become payable. Your customers will have no knowledge of the arrangements you have made. Invoice finance generally requires you to notate your invoices with the fact and full factoring results in the money being paid into the factoring company account.

The workings of each are slightly different but the effect is the same. Up to 85% of the debtor book can be drawn down. What is actually allowed will depend upon the perceived quality of your debtors the normal level of credits given by your company and how good the controls within the company are considered to be. Your draw down facility will be reduced to take account of any reciprocal trading, concentrations of trade, and any trade with a customer above and beyond the credit limit considered appropriate by the factoring company for that customer.

Such funding is usually relatively easy to arrange with bank statements and sight of recent accounts required. An audit of your controls within the business is also often required and this is usually conducted without charge by the factoring house.
There are a couple of other things of which you should be aware. You will normally pay a fixed fee for the service each year plus an interest charge on the draw down of 2 to 3% over base. There is therefore a cost to this service even if you never draw down and you are usually contracted to a minimum period.

One of the benefits of invoice finance which is often used as a selling point is that it automatically funds the increased working capital requirements of a growing business. As your turnover grows your debtor book increases in proportion and hence you have an increased funding source.

This of course is perfectly true but unless you are absolutely certain that your business will continue to grow or at the very least stay still, you should consider the opposite effect. The first effect of a reduced level of invoicing is to tighten your cash flow. You have become accustomed to paying your creditors due out of present invoicing rates. Your creditors due are as a consequence of previous activity rates and it will be a little time before they fall to matching the levels of the present activity levels

You should ensure that you have sufficient daylight in your arrangement to cover reducing invoicing rates to the extent that this may occur. Similarly if you have used this funding method to make a purchase of an asset you should be careful about the cover levels you have. If your invoicing rate declines so will your funding availability. You have, however, already spent the money on the asset.

Asset finance and stock finance etc are variations of secured funding and are methods of making clear the specific assets over which the funder has priority. Pursuing these may require deeds of priority to be drawn up if your bank has a fixed and floating charge. This is not usually an issue provided there is sufficient total security to cover the total funding required.

If you’re running out of security there is always the Small Firms Loan Guarantee Scheme. This works like senior debt and is organised through your bank. If you meet the criteria the DTI provides security for the loan.

Mezzanine finance is a hybrid which provides a mix of debt and equity finance as a bespoke solution to the specific situation. It is called mezzanine since the debt is repayable after the usual senior debt. The providers of such finance are looking for a return of 10 to 20% and you can find providers for deals of £5m plus. Companies with a low growth prospect or an inability to significantly increase cash flow after the deal are not suited to this method of funding.

Equity finance is really what it says. In return for a stake in the business investment funds are made available. This is unsecured funding and is therefore at the expensive end. Through a mixture of fees, coupon rate on preference shares, dividends and exit strategy the venture capitalist will be looking for a return of around 30%. This may be expensive and you have to come to terms with sacrificing equity but the VC rarely wants a controlling interest. Just enough to give him the chance of the return he requires. Remember 70% of something is worth more than 100% of nothing. If you believe in your business opportunity but have insufficient security then equity finance should be seriously considered.

You will need full and exhaustive business plans, full business controls and monthly management account reporting and formal board meetings with copies of minutes being supplied. Also, possibly, a non exec director of the VC’s choice. You, however, will have to pay for him. There will probably be restrictions on what you spend and how much you pay yourself and other directors but if you are professional and organised and able to achieve your plans these conditions are not onerous. In any event where else can you raise unsecured funding. They will also probably want a second charge ranking behind the banks.

You will also need to provide a clear, believable and achievable exit strategy for the VC over something of the order of a 3 to 5 year period. If you have what is commonly termed a lifestyle business there is little point in proposing an exit strategy of growth followed by sale. You would need to convince the VC that you actually would sell. The value of a minority shareholding is much less than a sale of the whole.