What to think about when raising finance

You know you need money. You know there a lots of options out there. But what do they all mean and where do you start? Before you hit google, let us try and shine some light on raising finance for you:

Why do you need external finance?

Whether it’s to enable growth by purchasing additional equipment, acquire a complimentary business or to extract value for the shareholders, be crystal clear what you are looking to do with this extra money. Is it a short term or long term financing requirement? A specific funding objective will help direct where you need to go hunting for money. Funders usually operate in particular niches so don’t waste time chasing the wrong people. Also, ensure you’ve considered all internal solutions first that could release capital to fund some or all of your needs?

Do the maths

Prior to approaching any finance provider, make sure you determine the external funding requirement. Be clear on what the costs and benefits are to your business and support this with an up to date business plan laying out clearly defined strategic objectives. Funders appreciate a well thought out submission ideally supported with a financial model that can test out various scenarios and sensitivities. For example, debt providers will want to make sure you are not going to breach any banking covenants they set.

Make yourself presentable

You’ve got your numbers but are you pitch ready? Like you, funders are busy people, so make sure you have your elevator pitch ready. It is the pre-cursor to opening the door to a meeting and further discussions.  Funders are looking for propositions that are succinct, well-articulated and that resonate with their funding criteria. The credit or investment decision making process for a debt provider or equity provider will be different. Preparation is key, including pre-empting the questions different funders will fire at you initially and later on during any due diligence process they conduct.

Don’t forget to consider:

• areas for improvement in the proposition;

• execution risks and mitigation strategies;

• taxation structuring considerations and optimal capital structure (i.e. debt and equity mix); and

• dividend policy.

A well thought out presentation will help appeal to a wider range of funders and help create more competitive tension and hopefully more offers to choose from.

So, who’s in the beauty parade?

There is a veritable wall of investment money out there but raising finance is a time consuming process and it pays to know who to approach first. Do your research thoroughly and draw up the front runners and a second tier B-list of targets. Speak to someone who knows the market to gauge funder appetite and likely pricing and terms. 

Here is a quick run through of the main sources of finance to consider:

Debt finance

• short term or long term loans provided by traditional banks, debt funds or peer-to-peer lending platforms;

• most relevant for businesses with demonstrable cash flows that are able to service the debt interest and repayment terms;

• interest rates and repayment terms will depend on the type of loan, the term length and the risk profile of the business;

• working capital facilities such as overdrafts and revolving credit facilities help manage daily operations and the cash conversion cycle;

• term loans are either secured against the assets of the business or a personal guarantee and tend to be repaid on an amortising basis or a bullet payment at the end of the term.

Asset based lending (ABL)

• loans provided against specific assets held by the business;

• helps release cash when cash flow is tight;

• most common form of ABL is “invoice discounting” where the lender provides a loan against the debtor book.

Asset finance or leasing

• lease provided to acquire use of new assets or refinance existing assets thereby releasing cash that would otherwise be tied up;

• a finance lease is where an asset is leased for the majority of its useful life, unlike an operating lease or hire contract agreement where the business eventually returns the asset back the leasing company (lessor);

• leases are typically longer term contracts than bank loans

Equity finance

• investment provided as share capital and loan notes;

• investors include private equity, venture capital, family offices, high net worth investors and individuals through the equity capital markets (AIM and FTSE on the London Stock Exchange) as well as crowdfunding platforms;

• equity investors typically need to see an exit route to sell their shares as a way to get a return on their investment whereas debt lenders are more focused on ensuring adequate cash head room to meet repayment terms;

• private equity investors tend to seek board representation and other legal provisions to protect their investment.

Mezzanine finance

• loans with the ability for the lender to convert the loan into equity if the debt isn’t repaid i.e. a hybrid between debt and equity;

• used to bridge a funding gap on a short term basis as usually have higher costs of servicing the loan than a standard loan.

Vendor loans

• loan is provided by the seller of the business as a way to finance the deal

• typically seen on management buyout deals (MBO);

• mainly a deferred loan but can also include an equity stake in the business.

Government grants

Often linked to schemes that help improve the economic prosperity of an area:

• Business Growth Fund – provide equity capital particularly for businesses that might not have success with traditional investment houses. Backed by the major banking institutions with an aim to provide capital into UK small and medium sized enterprises; and

• Regional Growth Fund – offers grants of £1m and above to businesses based in England.

Know what you are signing up to

You are one of the lucky ones to receive one or more offers, but how do you benchmark the terms and pricing being offered and what does this mean for your business and your shareholders? Understanding an offer letter or term sheet is critical to negotiating the best terms.

This is normally best done by inputting various financing structures on offer into a funding and operating model that can stress test it under a number of scenarios. On larger deals, there will be multiple sources of finance increasing the number of variables to stress test. For any debt component, make sure you can afford to pay interest, fees and repayment requirements and still have clear headroom to comfortably operate your business without breaching any terms or covenants they seeking to set. For any equity invested, the focus is existing shareholder value pre and post investment.

Analysing the quantitative aspects is key but don’t forget to also to consider the qualitative aspects of the offer.  Some example considerations include:

• implications of rights included within the shareholder agreement such as drag/tag rights and good/bad leaver provisions;

• interrelationship of funding agreements particularly Intercreditor agreements; and

• requirements for any hedge and derivative structuring as part of a debt package or risk management process.

Once you have negotiated the final commercial terms don’t forget it is equally as important to ensure those terms are accurately reflected in any legal documentation.

Before you sign, make sure you are happy the chemistry is right particularly with equity investors with board representation as you are going to have to work with them.

Well done the money is in, time to celebrate…?

Well, not quite. It would be foolhardy to think that once the money hits the bank account you can sit back and relax. More money means more responsibility. Now is the time for monitoring to ensure you deliver on the plan put to the funders and make sure you do not breach any of the terms that have been set.