Financing for Growth or Acquisitions
Organic growth is hard work, more so with the headwinds of Brexit, Covid and now the Ukraine war all creating drag, and yet there is superabundant capital, be it bank finance or equity looking for good returns. But which is best? Debt, equity or a mix? Financing for growth is can be tricky, and each approach should be tailored to achieve the optimal solution for your needs – appropriate, attainable and with the risk profile carefully considered – for example, banks may recall loans which are not serviced and equity funding is expensive.
The Business Stage
Businesses always require cash, particularly if they are growing, therefore the financing journey is continuous, with different approaches ranging from self-financing to third party debt or equity at different stages of a business’s overall lifecycle. Being able to access the right type of finance at the right time is vital for business growth and lifecycle. At the start, there may be overdrafts, or perhaps personal loans from family.
Later there may be institutional investors. When it comes to financing for growth or even acquisitions for that matter, management will need to ensure that future growth can be financed and for many leaders and entrepreneurs this is a challenge as invariably their focus is on products, customers and services and they often see finance as less exciting administration or only in the realm of accountants.
|Value can be gained and achieved by actively exploring both finance and cash management options and understanding which best suit the business life cycle at any point in time.|
Value can be gained and achieved by actively exploring both finance and cash management options. Analysis of a carefully prepared profit and loss and balance sheet forecasts and, crucially, the cash flow, allowing for seasonality, can clearly highlight how much capital the business needs for the current business plans. In turn, this analysis gives certainty and can create confidence and clarity to the leadership team along with a vision of where the business is going. Rather than an administration job, exploring cash flow and financing options can invigorate a business strategy.
Business Planning and Funding Information Pack
When we review our business plans, an acquisition, or our business cycle, we need to reinforce our thinking and the understanding of any potential lenders or equity providers with both information and a solid business plan. The plan helps lenders and investors to understand the vision and goals of the business. Plans should be simple – many leaders fail to secure funding with unfocused, jargon-filled propositions that do not address the risks. Information required includes:
- An executive summary which ‘grabs’ attention.
- Market analysis of the company, its products, services and competitors.
- Key accounting ratios and cash flow data.
- An analysis of the client base, particularly any demonstrable recurring elements.
- Details of key personnel, their responsibilities, skills and experience.
- A marketing plan targeting new or existing customers.
- Historic financial information; details of the last 3 plus years’ of trading
- Addressing downside risk.
- Forecasts for the next 2-3 years, ideally in the same style as historic financials.
- Cash flow forecasts covering a 3-year period, highlighting the amount of funding required and how creditors, capital expenditure, debtors and stock will be managed.
- Details of any tax reliefs available from investment in the venture.
- Commitment or ‘skin’ the shareholders are prepared to make/leave.
Equity Finance or Debt?
When it comes to financing for growth, debt is cheaper than equity, however, it may be riskier as banks or lenders may lend against cashflow or assets on a fixed schedule which may prove hard to ‘service’. Equity investment – raising capital through share sale – is more ‘patient’, however, buying back shares may prove costly, particularly if the venture is successful.
In relation to raising bank debt, security will often be a debenture against the business and its creditworthiness, rather than any specific asset – but it can also be personal, such as security on shareholder properties. This significantly reduces the lender’s risk but does increase the borrower’s risk.
A bullet loan can also feature in your financing for growth strategy – this is the business equivalent of an interest-only mortgage with a full capital holiday that repays the capital in a single repayment at the end of the loan. Because the capital is not repaid until the end of the loan period, cash is preserved in the business over this period as long as either the money retained in the business generates sufficient return to repay or refinance the bullet. Using debt may reduce a company’s corporation tax bill as some interest is deducted from profits before tax is calculated, making the financing for growth more nuanced than at first thought.
Leasing: Leasing or hire purchase are suited to larger longer-term purchases, such as investment in plant and machinery, computers or transport. Loans are secured largely on the asset being financed therefore the need for additional collateral is much reduced and there is more security for the user because the loan cannot be recalled during the life of the agreement.
Factoring and Invoice Discounting: Factoring involves the provision of finance via the purchase of invoices owed to a client. The factoring company will advance most of the value of the invoices on notification, with the balance remitted, when the invoices are paid by the client. The factoring company works on behalf of the business – managing the sales ledger and collecting money owed by customers.
Invoice discounting is the same as factoring except that the client business retains control over the administration. Both forms are low risk for lenders as their debt is recovered against the invoices. In acquisitions, the sales ledger of both the buyer and the seller can be assessed and a large percentage borrowed to fund the acquisition. The invoices do, however, need to be non-conditional.
Peer-to-Peer Lending: This is where individuals or companies lend directly to other companies, often via a platform, which helps broker the process. Peer-to-peer business lending can usually be arranged faster than a bank loan but often at much higher interest rates.
Mezzanine Finance: This form of debt shares the characteristics of equity but ranks below any senior (first) lending or debt. It is typically used to finance the expansion of existing companies via venture capital. As debt capital, it gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in full or on time. Mezzanine finance is used in product developments, penetration of new markets, infrastructure investments or strategic merger and acquisition plans. Such financing is usually structured with low cash payments and as it reduces the cash management in start-ups or fast growth businesses it is more appropriate than senior debt.
Export and Trade Finance: When businesses export, they need to be sure that they can afford to produce the goods and that they will be paid. Overseas suppliers may want to be paid for materials before shipping, so the need arises for finance to bridge the gap between the time a product is imported and when the finished product is sold.
Traditional export finance methods include lenders offering bonds and letters of credit. In a ‘bond’, if the seller fails to deliver the goods or services as described in the contract, the buyer can ‘call’ the bond and thereby receive financial compensation from the seller’s bank. In a ‘letter of credit’, if the buyer is unable to pay any of the entire agreed amount, the bank providing the letter of credit will offer to cover the shortfall.
Financing for Growth: Equity Options
Equity funding is ‘patient money’ in that it is committed to the business and its strategy in both good and bad times. Several issues need to be considered before selling a stake in your business in exchange for capital and investors should think about what protections are in place for their investment and what risks are involved. The main advantages of equity investment are:
- Investors and owners are aligned to secure value, growth and success on a longer-term basis. Investors may also bring expertise, contacts and drive beyond their capital.
- Investors, particularly private equity, can provide quick access to second-round funding as a business grows.
- It is now possible to crowdfund equity investment
|Sellers often retain a proportion of shares after a buyout; with the intention of a later sale at a materially ‘elevated’ value.|
Venture capitalists or private equity investors tend to be the option for the growth phase of a business, although they will often avoid sub-£500,000 profit companies. They view these as too owner-dependent and with insufficient surplus profits beyond the owners to scale-up. When it comes to using this as financing for growth, it is important to carry out reverse due diligence on investors and check how they will add value beyond money. They will typically seek to introduce better reporting and a more corporate management style and whilst this is usually positive, it can cause tension for highly cultural businesses.
Flotations (Initial Public Offerings) sell part or all the company to the public, giving access to ongoing public money, a liquid market for shares and typically a partial exit for existing ‘private’ shareholders. As floated companies are regulated and ‘liquid’, in that they trade daily, their valuations are higher than private companies. The listing of shares in public markets is expensive and requires significant work in a roadshow to line up investors, which is usually carried out by a NOMAD, a nominated adviser. For IPO’s the vision and venture usually needs to be sizeable.
Mergers and Acquisitions
If finance is raised for acquisitions, the deal structure will also have a bearing, vendor loan notes, earn-outs or share roll-overs can all be methods of reducing the upfront costs of an acquisition. Bank or equity debt can also facilitate leverage so that larger acquisitions or multiples can be looked at.
Financing for growth – fundraising – may be a chore, but it can add value. Modern enterprise combines the best business model with the right capital, debt and ownership structures central to business success.